BecomeATaxPreparer2009 1

2009 - 60 Hour
Federal and California

“Become A Tax Preparer” Course
Tax Ease, LLC

39270 Paseo Padre Pkwy #624 May 2009
Fremont, CA 94538
877-829-2667 www.taxeaseed.com
Fax: 510-779-5251
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Objectives
TaxEase’s objective is to:

Assist in preparing accurate tax returns
Give the convenience of studying in a comfortable setting.
Supply material that will give a wealth of information to use in future reference.
Offer services at an affordable cost
This Federal and California Qualifying Education class is a CTEC-approved course which
fulfills the 60-hour “qualifying education” requirements for tax preparers. A listing of additional
requirements to register as a tax preparer may be obtained by contacting CTEC at P.O. Box
2890, Sacramento, CA, 95812-2890, by phone at (877) 850-2832, or on the Internet at
www.ctec.org. TaxEase, LLC is an approved education provider, CTEC course number 3064-
QE-0002.
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Assignments
TaxEase’s Study Guide and the following sources are recommended reading before taking the final
exam:
IRS Pub. 17 Your Federal Income Tax

IRS Pub. 334 Tax Guide for Small Business
IRS Pub. 547 Casualties, Disasters, and Thefts
IRS Pub. 553 Highlights of Tax Changes
CA 540 and 540A Personal Income Tax Booklet
CA FTB Pub 1031 Guidelines for Determining Resident Status
CA FTB Pub 1001 Supplemental Guidelines to California Adjustments
Throughout the text, references have been made to other publications that will enhance the learning
process. We strongly recommend that these publications be ordered and reviewed. The IRS and FTB
form instructions give a wealth of information, which will be helpful in reviewing all aspects of tax
return preparation.
To receive Internal Revenue and California Franchise Tax Board publications call or visit their website:
IRS: (800) 829-3676 www.irs.gov

FTB: (800) 338-0505 www.ftb.ca.gov
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Certification and Instructions
1. Gather the IRS and the FTB Publications before beginning The TaxEase Study Guide.
2. The test material has been integrated into the study material, we recommend taking the tests after
reading each group of chapters. All tests are open book.
3. The study guides and tests are yours to keep for reference.
4. There is only one correct answer per question; all questions are True (A) / False (B) or multiple
choices (A – E). Circle the correct question in your text for reference and enter the correct letter on
our answer sheet provided with this material.
5. Complete all test sheets. Make sure your name and the date is on each answer sheet. Send the
completed answer sheet, the personal information page and the evaluation to:
TaxEase, LLC or FAX 510-779-5251

c/o Postal Annex
39270 Paseo Padre Parkway #624
Fremont, CA 94538
6. TaxEase will grade the test, a score of 70% or better is passing. Upon successful passing of the test,
we will send you a certificate suitable for framing, bonding information and instructions for
registering with the California Tax Education Council to become a licensed Tax Preparer in
California. Allow 10 days for the grading of the tests. Correct answers will not be provided.
7. If you do not pass the test the first time you may retake the test within 30 days at no additional
charge.
8. TaxEase is confident that you will find the information informative and helpful to your future tax
practice. If you wish to return the product, a full refund will be issued upon return of
all materials within 30 days of date ordered and prior to submission of any answer sheet for
grading.
The answer sheet is included on page 213 and 214. The personal information page is included on
page 215 and the evaluation is included on page 216. Be sure your name is on each page of the
answer sheet and the personal information sheet is complete.
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TABLE OF CONTENTS
OBJECTIVES .....................................................................................................................................................................2
ASSIGNMENTS.................................................................................................................................................................3
CERTIFICATION AND INSTRUCTIONS .......................................................................................................................4
CHAPTER 1 - THE BASICS..............................................................................................................................................9

IRS AND FTB FORMS AND PUBLICATIONS ................................................................................................................ 9
WHO MUST FILE? ..................................................................................................................................................... 9
STANDARD DEDUCTION .......................................................................................................................................... 10
WHEN TO FILE?....................................................................................................................................................... 11
PREPARER PENALTIES ............................................................................................................................................. 13
WHICH FORM TO FILE - FORM 1040EZ, FORM 1040A OR FORM 1040? .................................................................. 14
ACCOUNTING METHOD AND PERIODS ..................................................................................................................... 16
TEST CHAPTER 1 (QUESTIONS 1 THROUGH 37) .....................................................................................................17
CHAPTER 2- FILING STATUS AND DEPENDENTS ..................................................................................................23

GENERAL FILING STATUS INFORMATION ................................................................................................................ 23
COMMUNITY PROPERTY STATES ............................................................................................................................. 25
HEAD OF HOUSEHOLD FILING STATUS .................................................................................................................... 26
QUALIFYING PERSON ............................................................................................................................................... 30
EXEMPTIONS FOR DEPENDENTS .............................................................................................................................. 31
CHAPTER 2 QUESTIONS (38 THROUGH 60) .............................................................................................................35
CHAPTER 3 - WAGES AND 1099’S ..............................................................................................................................39

INCOME FROM 1099' S AND W-2' S ............................................................................................................................ 39
EMPLOYEE COMPENSATION .................................................................................................................................... 42
MISCELLANEOUS COMPENSATION .......................................................................................................................... 45
LIFE INSURANCE PROCEEDS .................................................................................................................................... 46
FRINGE BENEFITS .................................................................................................................................................... 46
CLERGY AND MILITARY .......................................................................................................................................... 47
EMPLOYEE BENEFITS .............................................................................................................................................. 48
WORKERS’ COMPENSATION .................................................................................................................................... 49
FOREIGN INCOME EXCLUSION ................................................................................................................................. 50
CHAPTER 3 QUESTIONS (61 THROUGH 80) .............................................................................................................51
CHAPTER 4 - INTEREST AND DIVIDENDS ...............................................................................................................54

INTEREST INCOME ................................................................................................................................................... 54
DIVIDEND INCOME .................................................................................................................................................. 55
NONTAXABLE DISTRIBUTIONS ................................................................................................................................ 56
CHAPTER 4 QUESTIONS (81 THROUGH 104)...........................................................................................................57
CHAPTER 5 – CANCELLATION OF DEBT, REFUNDS, ALIMONY AND BUSINESS INCOME...........................61

CANCELLATION OF DEBT ........................................................................................................................................ 61
STATE TAX REFUND ................................................................................................................................................ 62
ALIMONY RECEIVED ............................................................................................................................................... 62
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INDEPENDENT CONTRACTOR VS. EMPLOYEE........................................................................................................... 63
BUSINESS INCOME – SCHEDULE C........................................................................................................................... 64
SCHEDULE SE ......................................................................................................................................................... 70
CHAPTER 5 QUESTIONS (105 THROUGH 155)..........................................................................................................71
CHAPTER 6 - CAPITAL ASSETS ..................................................................................................................................79

BASIS OF PROPERTY ................................................................................................................................................ 79
STOCKS, BONDS AND MUTUAL FUNDS .................................................................................................................... 81
SALE OF PROPERTY ................................................................................................................................................. 81
GAIN AND LOSS....................................................................................................................................................... 82
CAPITAL GAIN TAX RATES ..................................................................................................................................... 82
SCHEDULE D ........................................................................................................................................................... 82
SALE OF BUSINESS PROPERTY (FORM 4797) AND INSTALLMENT SALES (FORM 6252)............................................ 85
CHAPTER 6 QUESTIONS (156 THROUGH 209)..........................................................................................................88
CHAPTER 7 - TYPES OF IRA’S AND EMPLOYER SPONSORED PENSION PLANS - DISTRIBUTIONS............95

DISTRIBUTIONS ....................................................................................................................................................... 96
REQUIRED MINIMUM DISTRIBUTION ....................................................................................................................... 96
ROLLOVERS OF PENSIONS AND IRA’S ..................................................................................................................... 98
FORM 1099-R.......................................................................................................................................................... 99
ADDITIONAL TAXES ON QUALIFIED PLANS (INCLUDING IRA’S) – FORM 5329 ....................................................... 99
EXCEPTIONS TO THE ADDITIONAL TAX ON FORM 5329......................................................................................... 100
CHAPTER 7 QUESTIONS (210 THROUGH 222)........................................................................................................101
CHAPTER 8 - RENTAL REAL ESTATE, K-1 INCOME AND LOSS, PASSIVE ACTIVITIES ...............................103
RENTAL INCOME - PUB 527................................................................................................................................... 103
RENTAL EXPENSES ................................................................................................................................................ 103
DEPRECIATION (FORM 4562) ................................................................................................................................ 105
SCHEDULE E.......................................................................................................................................................... 108
ROYALTY INCOME ................................................................................................................................................ 108
PASS-THROUGH INCOME FROM PARTNERSHIP, S-CORPORATION, ESTATE OR TRUST K-1’S .................................. 109
CHAPTER 9 - UNEMPLOYMENT COMPENSATION, SOCIAL SECURITY BENEFITS AND MISCELLANEOUS

INCOME.........................................................................................................................................................................116
UNEMPLOYMENT COMPENSATION ........................................................................................................................ 116
SOCIAL SECURITY BENEFITS ................................................................................................................................. 116
MISCELLANEOUS INCOME – LINE 21 FORM 1040 .................................................................................................. 117
CHAPTER 10- ADJUSTMENTS TO INCOME ............................................................................................................119

HEALTH SAVINGS ACCOUNT ................................................................................................................................. 119
ALIMONY PAID...................................................................................................................................................... 121
IRA....................................................................................................................................................................... 121
DOMESTIC PRODUCTION ACTIVITY DEDUCTION – FORM 8903 ............................................................................. 123
CHAPTER 10 QUESTIONS (264 THROUGH 295)......................................................................................................126
CHAPTER 11 – ITEMIZED DEDUCTIONS ................................................................................................................131

STANDARD DEDUCTION VS. ITEMIZED DEDUCTIONS ............................................................................................. 131
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ITEMIZED DEDUCTIONS ......................................................................................................................................... 132
MEDICAL AND DENTAL EXPENSES ........................................................................................................................ 132
TAXES ................................................................................................................................................................... 133
INTEREST............................................................................................................................................................... 134
GIFTS TO CHARITY ................................................................................................................................................ 134
CASUALTY AND THEFT ......................................................................................................................................... 135
JOB EXPENSES AND OTHER MISCELLANEOUS DEDUCTIONS.................................................................................. 136
FORM 2106 - EMPLOYEE BUSINESS EXPENSES ...................................................................................................... 136
DEDUCTIONS SUBJECT TO 2% OF ADJUSTED GROSS INCOME ................................................................................ 140
DEDUCTIONS NOT SUBJECT TO 2% LIMIT – SCHEDULE A, LINE 27 ....................................................................... 140
PHASE OUT OF ITEMIZED DEDUCTIONS ................................................................................................................. 140
STANDARD DEDUCTION ........................................................................................................................................ 141
CHAPTER 12 - TAXES AND CREDITS ......................................................................................................................150

TAX ....................................................................................................................................................................... 150
CAPITAL GAIN TAX RATES ................................................................................................................................... 150
“KIDDIE TAX” - TAX ON INVESTMENT INCOME OF CERTAIN MINOR CHILDREN ................................................... 151
ALTERNATIVE MINIMUM TAX ............................................................................................................................... 152
CREDITS ................................................................................................................................................................ 153
CHILD TAX CREDIT (IRC SECTION 24).................................................................................................................. 154
EDUCATION CREDITS (IRC SECTION 25(A)) ......................................................................................................... 155
OTHER TAXES ....................................................................................................................................................... 159
CHAPTER 13 - PAYMENTS, WITHHOLDING AND EARNED INCOME CREDIT................................................167

WITHHOLDING ...................................................................................................................................................... 167
ESTIMATED TAX ................................................................................................................................................... 168
EARNED INCOME CREDIT ...................................................................................................................................... 168
EITC DUE DILIGENCE ........................................................................................................................................... 170
CHAPTER 14 – REFUNDS, AMOUNT DUE & ELECTRONIC FILING ...................................................................175

REFUND................................................................................................................................................................. 175
AMOUNT OWED .................................................................................................................................................... 175
ELECTRONIC FILING - FEDERAL AND CALIFORNIA ................................................................................................ 176
CHAPTER 15 – VARIOUS TAXES ..............................................................................................................................181

GIFT AND ESTATE TAX.......................................................................................................................................... 181
EXCISE TAX .......................................................................................................................................................... 181
FEDERAL AND STATE UNEMPLOYMENT TAX (FUTA AND SUI)............................................................................ 182
CHAPTER 16 –THE BASIC CALIFORNIA RETURN ................................................................................................184

WHO MUST FILE A CALIFORNIA TAX RETURN? .................................................................................................... 184
EXEMPTIONS - 2008 .............................................................................................................................................. 185
CALIFORNIA STANDARD DEDUCTIONS .................................................................................................................. 185
FORM 5402EZ, FORM 540A OR FORM 540............................................................................................................ 186
COMMUNITY PROPERTY STATE ............................................................................................................................. 186
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ALTERNATIVE MINIMUM TAX - 2008.................................................................................................................... 187
CHILDREN UNDER THE AGE OF 14 WITH INVESTMENT INCOME ............................................................................ 187
EXCESS SDI OR VPDI WITHHELD ......................................................................................................................... 187
CALIFORNIA CREDITS ........................................................................................................................................... 188
INTEREST AND PENALTIES ..................................................................................................................................... 190
POWER OF ATTORNEY ........................................................................................................................................... 190
VOLUNTARY CONTRIBUTIONS............................................................................................................................... 191
CHAPTER 17 - CALIFORNIA RESIDENCY AND NON-RESIDENT .......................................................................196

SAFE HARBOR ....................................................................................................................................................... 197
TYPES OF INCOME ................................................................................................................................................. 197
CHAPTER 18 - CALIFORNIA CONFORMITY, SCHEDULE CA..............................................................................202

CAPITAL GAIN OR LOSS ADJUSTMENT .................................................................................................................. 204
FTB FORM 3885A – DEPRECIATION ..................................................................................................................... 204
CHAPTER 19 ETHICS – FEDERAL AND CALIFORNIA ..........................................................................................207

SECTION 7216 UPDATED RULES FOR TAX PREPARERS (UPDATED 12/18/2008) .................................................... 207
FEDERAL – CIRCULAR 230 .................................................................................................................................... 208
CALIFORNIA - CTEC ............................................................................................................................................. 209
TAX PREPARER CODE OF CONDUCT AND RESPONSIBILITIES ................................................................................. 210
PREPARER PENALTIES ........................................................................................................................................... 211
PERSONAL INFORMATION FORM ...........................................................................................................................217
2009 - 60 HOUR “BECOME A TAX PREPARER” EVALUATION ...........................................................................218
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Chapter 1 - The Basics
IRS and FTB Forms and Publications
On page 3 of this text we recommend IRS and FTB publications. Publication 17
and Form 1040 Instructions are extremely valuable when preparing returns.
Publication 17 outlines the basics and gives references throughout of other publications for
specific items. Form 1040 Instructions provide line by line instructions for filling out Form 1040
and makes reference to the other forms which must be completed in a particular return.
FTB Pub 1001 – The Supplemental Guidelines to California Adjustments describes the
adjustments that must be made to the California return. The California return begins with the
Federal adjusted gross income; Publication 1001 describes the required adjustments between the
Federal and California return and how to report these differences.
Who Must File?
All US citizens, regardless of where they live, and resident aliens must determine whether they are
required to file a tax return. The determination is based on the following three factors:
1. Gross Income
2. Filing Status…and
3. Age
From 2008 Pub 17
A return must be filed if any of the following four conditions below apply:
1. The taxpayer owes special taxes, such as: Social Security or Medicare taxes on tips that were not
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reported to the employer, Alternative Minimum Tax, recapture taxes or tax on a qualified plan
including IRA or other tax-favored account.
2. The taxpayer had earnings from self-employment of at least $400.
3. Any advanced earned income payments were received.
4. There are wages of $108.28 or more from a church that is exempt from employer social security
and Medicare taxes.
Standard Deduction
The standard deduction is a dollar amount that reduces the amount of income on
which the taxpayer is taxed. The standard deduction is allowed only if the
taxpayer does not have itemized deductions.
In general, the basic standard deduction is an amount relative to each tax year
and varies according to the filing status. The standard deduction of an
individual who can be claimed as a dependent on another person' s tax return is the greater of:
• An amount specified by law, or
• The individual' s earned income plus a specified amount up to the basic standard deduction
for his or her filing status
In some cases, the standard deduction can consist of two parts, the basic standard deduction and
additional standard deduction amounts, for age, or blindness, or both. The additional amount is an
amount specified by law and varies based on the filing status.
The additional amount for age will be allowed if the taxpayer is age 65 or older at the end of the tax
year. The taxpayer is considered to be 65 on the day before their 65th birthday. The additional amount
for blindness will be allowed if the taxpayer is blind on the last day of the tax year.
Certain individuals are not entitled to the standard deduction. They are:
• A married individual filing a separate return whose spouse itemizes deductions,
• An individual who was a nonresident alien or dual status alien during any part of the year, or
• An individual who files a return for a period of less than 12 months due to a change in his or
her annual accounting cycle
Standard Deduction
2008 2009
Single or Married Filing Separate $5,450 5,700
Married Filing Joint or Qualified Widow(er) $10,900 11,400
Head of Household $8,000 8,350
Real Estate Taxes - NEW IN 2008

The standard deduction is increased by the state and local real estate taxes paid, up to $500 ($1,000 if
married filing jointly). The real estate taxes must be taxes that would have been deductible on Schedule
A if the taxpayer had itemized their deductions. Taxes used to arrive at adjusted gross income (such as
taxes on business real estate) and taxes on foreign real estate cannot be used to increase the standard
deduction.
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Net Disaster Loss – NEW IN 2008
The standard deduction is increased by the taxpayer’s net disaster loss. The net disaster loss is the
personal casualty losses from a federally declared disaster minus any personal casualty gains as
computed on Form 4684. Refer to instructions for Form 4684 for more information.
Example: Standard Deduction Worksheet – 2008 Form 1040 Line 40
Deduction for Exemptions Worksheet – 2008 Form 1040 Line 42

2008 personal exemption = $3,500 2009 personal exemption = $3,650
When to File?
Tax returns for individual taxpayers are due by the 15th day of the fourth month after the
close of the tax year (April 15th for calendar year taxpayers). If the return is filed after
this date it is subject to interest and penalties. If the taxpayer needs an extension of time Form 4868
requesting an automatic 6-month extension must be filed.
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The due date that falls on a Saturday, Sunday or legal holiday for filing tax forms is delayed until the
next business day.
Interest
Interest will be charged on tax returns not paid by the due date, even if an extension of time is granted.
Interest is also charged on penalties imposed for failure to file, negligence, fraud, substantial valuation
misstatements, and substantial understatements of tax. Interest is charged on the penalty from the due
date of the return (including extensions).
The IRS will pay interest on overpayment of tax if the refund is not issued 45 days after the tax return is
filed. If the refund is issued within 45 days of the filing date there is no interest. The interest adjusts
quarterly. Accepting a check from the IRS does not change the right of the taxpayer to claim an
additional refund and interest. A claim for additional refund should be filed on Form 1040X.
Amended Returns
Errors and omissions on a return can lead to additional refund or additional amount owed. The return
should be corrected if:
1. Not all income was reported
2. Deductions and credits were claimed that should not have been claimed.
3. Deductions and credits were not claimed that should have been claimed.
4. The filing status claimed was incorrect.
Form 1040X must be completed showing the return as originally filed, as well as the changes, and
computation of the tax using the amended return. Form 1040X with the claim for an additional refund or
a check for the amount owed must be filed within 3 years after the date the original return was filed or 2
years after the date the tax was paid, whichever is later. The return should be filed at the same service
center as the original return. (Refer to Form 1040X instructions for further information).
Penalties
Late Filing: If the return is not filed by the due date (including extensions), the penalty is usually 5% of
the amount due for each month or part of the month the return is late, unless there is a reasonable
explanation. The explanation must be attached to the return. The penalty can be as much as 25% (more
in some cases) of the tax due. If the return is more than 60 days late the minimum penalty will be $100
or the amount of any tax owed whichever is smaller.
Late Payment of Tax: If the taxes owed are paid late the penalty is usually 1/2 of 1% of the unpaid
amount for each month or part of the month the tax is not paid. This is known as the failure-to pay
penalty. The penalty can be as much as 25% of the unpaid amount. It applies to any unpaid amount on
the return. This penalty is in addition to interest charges on the late payments. The penalty does not
apply during the automatic 6-month extension of time to file.
Negligence and disregard: The term negligence includes failure to make a reasonable attempt to
comply with the tax law or to exercise ordinary and reasonable care in preparing the tax return and
adequate books and records. This accuracy penalty includes any careless, reckless, or intentional
disregard.
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Substantial understatement of income tax: An understatement is considered substantial if it is more
than the largest of 10% of the correct tax or $5,000. Negligence, disregard and substantial
understatement of income are all considered accuracy related penalties. Accuracy related penalty is
equal to 20% of the underpayment.
Paid Preparers
If the return is prepared by a paid preparer, that preparer must register with The
California Tax Education Council unless that person meets one of the following
exemptions:
1. Persons licensed with the State Board of Accountancy and their employees
2. Persons who are active member of the State Bar of California and their employees
3. Employees of certain Trust Companies
4. Persons enrolled to practice before the Internal Revenue Service and their employees
5. Companies and their employees of Financial Institutions regulated by state or federal
government
The preparer must complete at least 60 hours of instruction in basic personal income tax law, theory and
practice within the past 18 months. 20 hours of continuing education is required in all subsequent cycles.
A paid preparer other than those mentioned above must acquire a tax preparer bond in the amount of
$5,000. The California Business and Professions Code Section 22250 requires that a bond be acquired
through a surety company admitted to do business in California and shall be maintained for each
individual preparing returns for another person. The tax preparer is required to give the client prior to
preparing the tax return, their name, address, telephone number and evidence of compliance with the
bonding requirement.
Tax preparers who violate the Business and Professions Code may be subject to a fine of up to $1,000, a
civil penalty of up to $1,000 and up to one year in county jail.
The tax preparer has a requirement to furnish and retain a copy of the return he has prepared. The
return can be kept on magnetic media and shall be kept for a period of at least 4-years from the time the
return was filed. The taxpayer must sign the return and use either an employer identification number, a
social security number or a personal taxpayer identification number (PTIN).
Preparer Penalties
The following are some of the penalties that can be assessed against tax preparers:
• Failure to furnish a copy of the return to the taxpayer $50 per return up to $25,000
• Failure to sign a return $50 per return up to $25,000
• Failure to furnish preparer’s identification number $50 per return up to $25,000
• Failure to maintain copies of the return $50 per return up to $25,000
• Understatement of taxpayer’s liability due to unrealistic position - $250 per return
• Understatement due to preparer’s willful or reckless conduct - $1,000 per return
• Failure to maintain records of preparer’s in office - $50 per preparer up to $25,000
• Improper disclosure of return information - $250 for each disclosure up to $10,000
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Where to file?
The addresses above are for taxpayers, tax preparer’s should refer to www.irs.gov for filing
addresses.
Which Form to File - Form 1040EZ, Form 1040A or Form 1040?
The taxpayer can use Form 1040 EZ if the following is true:
• The filing status is single or married filing a joint return
• The taxpayer (and spouse if married filing joint) were under age 65 and not blind at the end
of 2008
• There are no dependents on the return
• The taxable income is less than $100,000
• The taxpayer did not claim any adjustments to income.
• The taxpayer did not claim any credit except EIC or recovery rebate credit.
• The only income is from salaries, wages, tips, taxable scholarship or fellowship grants,
unemployment compensation, Alaska Permanent Fund and the taxable interest is not over
$1,500
• No advanced earned income payments were received.
• The taxpayer did not claim any additional standard deduction for real estate taxes or disaster
losses.
The taxpayer can use Form 1040A if all five of the following apply:
1. The only income was from the following sources:
• Wages, salaries, tips
• Interest and ordinary dividends
• Capital gain distributions
• Taxable scholarship and fellowship grants.
• Pensions, annuities and IRA' s.
• Unemployment compensation.
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• Taxable social security and railroad retirement benefits.
• Alaska Permanent Fund dividends.
2. The only adjustments to income that can be claimed are:
• Educator expenses.
• IRA deduction.
• Student loan interest deduction.
• Tuition and fees deduction.
3. No itemized deductions are taken.
4. The taxable income is less than $100,000.
5. The only tax credits that can be claimed are:
• Child tax credit.
• Additional child tax credit.
• Education credits.
• Earned income credit.
• Credit for child and dependent care expenses.
• Credit for the elderly or the disabled.
• Adoption credit.
• Retirement savings contribution credit.
• Recovery rebate credit
The taxpayer must use Form 1040 if any of the following apply:
1. The taxable income is $100,000 or more
2. The taxpayer has income that cannot be reported on 1040A or 1040EZ.
3. The taxpayer can exclude either of the following types of income:
• Foreign earned income received as a U S citizen or resident alien.
• Certain income received from sources in a U. S. possession, if a bona fide resident of
American Samoa for all of 2008.
4. The taxpayer can claim any adjustments to gross income other than the adjustments listed earlier
under Form 1040A.
5. The taxpayers’ W-2, box 12, shows uncollected employee tax (social security and Medicare tax on
tips or group-term life insurance).
6. The taxpayer received a distribution from a foreign trust.
7. The taxpayer is reporting original issue discount more or less than the amount shown on Form
1099-OID.
8. The taxpayer has to file other forms with his/her return to report certain exclusions, taxes, or
transactions.
9. The taxpayer claims any credits other than credits listed earlier under Form 1040A.
10. The taxpayer owes household employment taxes
11. The taxpayer is eligible for health coverage tax credit
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Accounting Method and Periods
The accounting method is the way the taxpayer accounts for his/her income and expenses. Most
taxpayers use either the cash or accrual method of accounting. The method is chosen the first time a
return is filed; approval is needed by the IRS to change the accounting method.
If the taxpayer uses the cash method, all items of income are reported in the year they are received or
constructively received. Expenses are deducted in the year they are paid. Constructive receipt is when
the funds become available to use without restriction whether they are in the physical possession of the
taxpayer or not.
In general, the cash method cannot be used to account for inventory purchases and sales. However, an
exception is allowed for taxpayers with an average annual gross receipt of $1 million or less.
If the taxpayer uses the accrual method, the income is generally reported when earned, not received.
The expenses are reported when incurred, not paid. Accounts payable and accounts receivable books
must be maintained. The accrual method must be used to account for inventory purchases and sales.
Hybrid method is a combination of accrual and cash. The most common hybrid uses the accrual
method for inventory purchases and sales; and the cash method for non inventory income and operating
expenses.
Most individual tax returns cover a calendar year – the 12 months from January 1 through December
31st. If the taxpayer does not use a calendar year, the accounting period is a fiscal year. A regular fiscal
year is a 12-month period that ends on the last day of any month other than December. A 52-53 week
fiscal year varies form 52 to 53 weeks and always ends on the same day of the week.
The accounting period is chosen when the first return is filed; the accounting period cannot be longer
than 12 months. For additional information on accounting methods or periods refer to Pub. 538.
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Test Chapter 1 (Questions 1 through 37)
1. Which of the following publications describe the adjustments between Federal and
California returns?
A. FTB Pub 1001
B. Publication 17
C. Publication 334
D. Form 1040 Instructions
2. Which one of the following is not a determination of whether a person must file a tax return?
A. Residency
B. Filing status
C. Gross Income
D. Age
3. A single person age 65 or older must file a return if their gross income is at least____________.
A. $8,950
B. $10,300
C. $18,950
D. $11,500
4. For most people filing a return is required when:

A. Gross income exceeds the standard deduction amount plus the exemption amount
B. There is self-employment income
C. Alternative Minimum Tax
D. Any of the above.
5. 2008 Publication 17 states that gross income means all income that is received in the form of the
following, except:
A. Money
B. Property
C. Services that are not tax exempt
D. Real estate taxes paid
6. Which of the following items can increase the taxpayer’s standard deduction?
A. Foreign real estate taxes.
B. Business property real estate taxes
C. State real estate taxes
D. All of the above.
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7. Personal casualty losses which increase the standard deduction are computed on Form 4684.
A. True.
B. False
8. The tax return for a calendar year taxpayer is due on:

A. The 15th day of the 4th month after the close of the taxable year.
B. April 1st
C. August 15th
D. The 15th day of the 3rd month after the close of the taxable year.
9. The due date that falls on a Saturday, Sunday or legal holiday for filing tax forms is delayed until the
next business day.
A. True
B. False
10. Form 4868 is used:

A. To request an automatic 6-month extension of time to file the tax return.
B. To report self-employment tax
C. To report miscellaneous income
D. To request an automatic 4-month extension of time to pay the tax owed.
11. Which of the following is not true regarding interest?

A. Interest will be charged on tax returns not paid by the due date, even if an extension of
time is granted.
B. Interest is charged on the penalty from the due date of the return (including extensions).
C. Accepting a check from the IRS does not change the right of the taxpayer to claim an
additional refund and interest.
D. A claim for additional refund cannot be filed on Form 1040X.
12. A return should be amended for the following reasons, except:

A. Not all income was reported
B. Deductions and credits were claimed that should not have been claimed
C. Deductions and credits were not claimed that should have been claimed
D. Everything was reported correctly on the original return
13. Which of the following is not an accuracy related penalty?

A. Negligence penalty
B. Disregard penalty
C. Penalty for substantial under reporting of income
D. Penalty for late filing of the tax return.
14. Generally, if the return is not filed by the due date, the penalty is:
A. 10% of the amount due for each month or part of the month the return is late
B. 5% of the amount due for each month or part of the month the return is late
C. 15% of the amount due for each month or part of the month the return is late
D. A $5.00 late fee
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15. The failure-to-pay penalty on the unpaid amount of tax due can be as much as:
A. 10%
B. 50%
C. 25%
D. 5%
16. If the return is more than 60 days late the minimum penalty will be:
A. $75.00 or the amount of any tax owed, whichever is greater
B. Equal to the amount of tax owed
C. $100 or the amount of any tax owed whichever is smaller
D. $150
17. The term for a tax return that is carelessly prepared and without adequate records is considered to be
done with:
A. Oversight and omission
B. Inattention and neglect
C. Negligence and disregard
D. Indifference and disinterest
18. Which of the following are required to be registered with the California Tax Education Council to
prepare tax returns:
A. Persons licensed with the State Board of Accountancy and their employees
B. Persons who are active member of the State Bar of California and their employees
C. Persons enrolled to practice before the Internal Revenue Service and their employees.
(EA)
D. None of the above.
19. To be a registered CTEC preparer the student must complete at least 60 hours of instruction in basic
personal income tax law, theory and practice within the past 18 months. 20 hours of continuing
education is required in all subsequent cycles.
A. True
B. False
20. The California Business and Professions Code Section 22250 require that a bond be posted, which of
the following are requirements of the bond?
A. The surety company must be admitted to do business in California
B. The bond must be maintained for each individual preparing returns for another person.
C. The amount of the bond must be $5,000
D. All of the above
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21. The tax preparer has a requirement to furnish and retain a copy of the return he has prepared.
A. The return can be kept on magnetic media
B. The returns must be kept for a period of at least 4-years from the time the return was
filed.
C. The taxpayer must sign the return and use an employer identification number, a social
security number or a personal taxpayer identification number.
D. All of the above
22. Which of the following is not a preparer penalty?

A. Failure to furnish a copy of the return to the taxpayer $50 per return up to $25,000
B. Failure to sign a return $50 per return up to $25,000
C. Underpayment of Estimated Tax by Individuals
D. Failure to maintain copies of the return $50 per return up to $25,000
23. The taxpayer can use Form 1040EZ when the taxable income is less than:
A. $75,000
B. $50,000
C. $100,000
D. $40,000
24. The taxpayer can use Form 1040A when reporting the following, except:
A. Interest and ordinary dividends
B. An IRA deduction
C. Education Credits
D. Distribution from a foreign trust
25. Which of the following is not a condition requiring form 1040 to be filed?
A. The taxpayer owes alternative minimum tax
B. The taxpayer has social security benefits
C. The taxpayer has self-employment earnings
D. Received foreign earned income
26. A taxpayer that lives in Maine, owes $456 and prepares his own return must file Form 1040 at
which of the following locations?
A. Any filing center as long as the return is filed by April 15th
B. P O Box 37002, Hartford CT 06176
C. Austin, TX 73301-0215
D. Andover, MA 05501-0102
27. Which of the following returns are not required to be filed at the Austin TX filing center?
A. Form 1040 that includes an earned income exclusion, form 2555
B. A return from a resident of Kentucky.
C. A return from a resident of America Samoa
D. A resident of CA who is filing Schedule F to report farm income.
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28. Which of the following is not true regarding when the taxpayer can use Form 1040EZ?
A. The filing status is single or married filing a joint return.
B. The taxpayer (and spouse if married filing joint) were under age 65.
C. There are no dependents on the return.
D. The income must be under $50,000.
29. Which of the following is not true regarding when the taxpayer can use Form 1040A?
A. Income from wages, salaries, and tips are allowed
B. Interest and dividend income are allowed
C. Capital gain distributions are allowed
D. Self-employment income is allowed
30. Which of the following is allowed on Form 1040A?

A. Child tax credit
B. Recovery rebate credit
C. Student loan interest deduction
D. All of the above
31. All of the following is income that requires the taxpayer to File form 1040, except
A. Interest and dividend income under $1500.
B. Nontaxable distributions required to be reported as capital gains
C. Tips not reported to the employer
D. Income received as a shareholder in an S-Corporation.
32. Foreign earned income requires the taxpayer to file which of the following forms?
A. Form 1040
B. Form 1040A
C. Form 4562
D. Schedule C
33. If the taxpayer uses the cash method of accounting, which of the following statements are correct?
A. Income is reported in the year received or constructively received
B. Expenses are deducted in the year they are paid
C. Income is reported when earned
D. Both A and B
34. A regular fiscal year is a 12-month period that ends:

A. December 31st
B. The first day of any month other than December
C. The last day of any month other than December
D. Always on November 30th
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35. Which of the following is not true regarding sources of gross income?
A. Money
B. Goods
C. Property
D. Only income earned in the United States
36. The filing status determines the rate at which his or her income is taxed.
A. True
B. False
37. Which of the following is not one of the five filing status?
A. Single
B. Married filing a joint return
C. Head of household
D. Divorced
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Chapter 2- Filing Status and Dependents
General Filing Status Information
Generally, the marital status on the last day of the year determines the
filing status for the entire year.
If the taxpayer is unmarried, or is legally separated from the spouse
under a divorce or separate maintenance decree according to state law,
and the taxpayer does not qualify for another filing status, the filing
status is single.
Generally, to qualify for head of household status, the taxpayer must be unmarried and must
have paid more than half the cost of maintaining a household that was the main home for a
qualifying person for more than half the year. The taxpayer may also qualify for head of
household status if, though married, the taxpayer filed a separate return, and the spouse was not a
member of the household during the last six months of the tax year, and the taxpayer provided
more than half the cost of maintaining the home as a household that was the main home for more
than one half of the tax year of a qualifying person.
If the taxpayer is married, the taxpayer and spouse may file a joint return or separate returns. If
the spouse died and the taxpayer did not remarry in the year that the spouse died, the taxpayer
may still file a joint return for that year. This is the last year for which the taxpayer may file a
joint return with that spouse.
The taxpayer may be able to file as a qualifying widow or widower for the two years following
the year the spouse died. To do this, the taxpayer must meet all four of the following tests:
A. The taxpayer is entitled to file a joint return with the spouse for the year he or she died. It
does not matter whether the joint return was actually filed,
B. The taxpayer did not remarry in the two years following the year the spouse died,
C. There is a child, stepchild, or adopted child (a foster child does not meet this
requirement) for whom the taxpayer can claim a dependency exemption,
D. The taxpayer paid more than half the cost of maintaining a household that was the main
home for the taxpayer and child the entire year.
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After the two years following the year in which your spouse died, the taxpayer may qualify for
head of household status.
The except here is from FTB
Pub 1051A.
California Registered Domestic Partners (RDP) and Same-Sex Married Couples

(SSMC’s)
RDP’s and SSMC’s under California law must file their CA income tax returns using either the
married/RDP filing jointly or married/RDP filing separately filing status. RDP’s have the same
legal benefits protections and responsibilities as married couples unless otherwise specified.
If the taxpayer enters into a same sex legal union in another state other than marriage and that
union has been determined to be substantially equivalent to CA registered domestic partnership,
the taxpayer is required to file using married/RDP filing jointly or filing separately filing status.
For CA purposes references to a spouse, husband or wife also applies to a registered domestic
partner.
Because the IRS does not recognize either SSMC’s or RDP’s the taxpayer must continue to file
as an unmarried person on their Federal return.
That’s the General, Here are some Specifics on Filing Status
Married Filing Separate

Unless the taxpayer is required to file married filing separately, the taxpayer
should compare the married filing joint to the married filing separate for the
lowest tax. When filing married filing separately the taxpayer generally will pay
more combined tax than married filing joint.
Items Related to Married Filing Separate

A. The tax rate generally will be higher than it would be on a joint return.
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B. The exemption amount for figuring the alternative minimum tax will be half that allowed
for a joint return filer
C. The taxpayer cannot take the child and dependent care expenses in most cases. See Form
2441 for more information.
D. The taxpayer cannot take the earned income credit.
E. The taxpayer cannot take the exclusion or the credit for adoption expenses in most cases.
F. The taxpayer cannot take the education credits or student loan interest
G. The taxpayer cannot exclude interest income from U.S. Savings Bonds used for higher
education.
H. If the taxpayer lived with the spouse at any time during the tax year
a. The taxpayer cannot claim the credit for the elderly or the disabled
b. The taxpayer will have to include in income more (up to 85%) of any social
security income or equivalent railroad retirement benefits received.
c. The taxpayer cannot rollover amounts from a traditional IRA to a Roth IRA.
I. The following deductions and credits are reduced at income levels that are half those of a
joint return:
a. The child tax credit,
b. The retirement savers credit
c. Itemized deductions
d. The deduction for personal exemptions
J. The capital loss limit is $1,500 (instead of $3,000 if filing a joint return)
K. If the spouse itemizes the taxpayer is required to itemize and cannot take a standard
deduction.
L. The special loss allowance for rental real estate is $12,500 (instead of the $25,000) for
married filing joint.
M. An IRA deduction is diminished if one of the spouses is in a qualified plan. See Pub 17,
Chapter 17 for further information.
If the taxpayer and spouse file separate returns generally the filing status can be changed to a
joint return within three years from the due date of the separate returns. In this situation a
separate return includes a return filed by the taxpayer or spouse using the filing status; married
filing separate, single or head of household.
If the taxpayer filed a joint return the taxpayer cannot choose to file a separate return for that
year after the due date of the return.
Community Property States
Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin
are community property states. Income in community property states may be considered separate
or community depending on state law. Refer to Pub 555 for more information.
California and Married Filing Separate

Income generated from community property is community income. Community income includes
compensation for services if the spouse earning the compensations is domiciled in a community
property state.
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Community income must be split between the taxpayer and spouse equally when filing separate
returns. Community status ends when marital partners physically separate with no immediate
intention of reconciliation.
Separate property is:

• Property owned separately by a spouse before marriage
• Property received separately as gifts or inheritances.
• Property purchased with separate property funds
• Money earned while domiciled in separate property states
• All property declared separate property in a valid agreement (pre-or-post nuptial)
Separate property belongs to the spouse who owns it. The taxpayer must maintain the property
separately. If they use the property for community purposes, or if they commingle it, it could
lose the separate property character, overriding agreements.
Head of Household Filing Status
This section applies to Federal and California.
If the taxpayer was married as of the last day of the tax year or if the spouse died during the tax
year, the taxpayer may be considered unmarried for head of household purposes. The taxpayer
may be considered unmarried if they meet all of the following requirements:
• The qualifying person is the taxpayer’s birth child, stepchild, adopted child, or eligible
foster child.
• The taxpayer filed a tax return separate from their spouse' s tax return.
• The taxpayer paid more than one-half the cost of keeping up the home for the taxable
year.
• The spouse did not live in the taxpayer’s home at any time during the last six months of
the taxable year.
• The home was the main home for the taxpayer and the birth child, stepchild, adopted
child, or eligible foster child for more than half the year.
• The taxpayer must be entitled to claim a dependent exemption credit for the child. The
child must meet the requirements to be either a qualifying child or qualifying relative and
meet the joint return and citizenship tests. However, the taxpayer cannot claim a
dependent exemption credit for the child if they can be claimed as a dependent by another
taxpayer.
The taxpayer can still meet this requirement if they cannot claim a dependent exemption
credit for the qualifying child because the following applies in their decree of legal divorce or
legal separation:
o The noncustodial parent is entitled to the dependent exemption credit for the
child, or
o The custodial parent signed a written statement not to claim the dependent
exemption credit for the child. (The custodial parent may sign federal Form 8332,
Release of Claim to Exemption for Child of Divorced or Separated Parents, or a
similar statement.) The noncustodial parent must attach a copy of the statement to
each applicable income tax return.
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Dependent exemption credit
The taxpayer qualifies for a dependent exemption credit for a person if the qualifying person
meets:
• The requirements to be either a qualifying child or a qualifying relative, and
• The joint return and citizenships tests. If the qualifying person files a joint return with
someone else, refer to Pub 17, to determine if that person can be a qualifying person. To
meet the citizenship test, for some part of the calendar year in which the tax year begins,
the qualifying child or qualifying relative must be a U.S. citizen or national, or a resident
of the U.S., Canada, or Mexico.
Divorced
There must have a final judgment for dissolution of marriage that is effective by the last day of
the tax year to be divorced. Living apart from the spouse or filing a petition for divorce is not the
same as having final decree of divorce.
Eligible foster child

An eligible foster child is a child placed with the taxpayer by an authorized placement agency or
by a judgment, decree, or other order of a court of competent jurisdiction. Generally, formal
placement ends when the child reaches the age of 18.
To qualify for head of household filing status, the eligible foster child must meet the
requirements of a qualifying child or a qualifying relative. These requirements include the
following:
• The child must live with the taxpayer for more than half the year.
• The taxpayer must pay more than half the cost of keeping up the home.
If a governmental agency or a tax-exempt child placement agency makes payments to the

taxpayer as a foster parent, they are not entitled to claim a dependent exemption credit for the
child. If the taxpayer is not entitled to claim a dependent exemption credit for the child, they do
not qualify for the head of household filing status on the basis of this child.
Full-time student
A full-time student is a person who during some part of each of five calendar
months during the year attended a school. The school must have a:
• Regular teaching staff.
• Course of study.
• Regularly enrolled body of students in attendance.
Joint custody
If the taxpayer and spouse share joint custody of the child, to qualify for the head of household
filing status the taxpayer must still meet all the requirements for the filing status. These
requirements include the following:
• The child must have lived with the taxpayer for more than half the year.
• The taxpayer must have paid more than half the cost of keeping up the home.
27
Keeping up the home
The taxpayer is keeping up a home only if they pay more than one-half the cost of keeping up the
home for the year. Generally, if two or more people keep up the same home, only one of the
people could pay more than half the costs and qualify for the head of household filing status.
If two or more families occupy the same dwelling, but maintain separate finances, and each
family does not contribute to the support of the other family, each family may be treated as
keeping up a separate home. The taxpayer who provides more than one-half the cost of
maintaining that separate home is treated as keeping up that separate home.
Main Home
For more than half the year, the home must be the main home and the main home of the person
who the taxpayer believes qualifies for head of household filing status. Generally, the location of
the taxpayer and the other person' s main home is determined by where the taxpayer and the other
person actually lived. The taxpayer and the other person must live together in the home for more
than half the year, except for temporary absences.
Married
If the taxpayer is not unmarried under the situations shown under unmarried, the taxpayer is
married. If the taxpayer was married as of the last day of the year and lived with the spouse at
any time during the last six months of the year, the taxpayer cannot qualify for head of household
filing status.
More than half the year

Just because someone lived with you for six months does not mean that the person lived with
you for more than half the year. A year has 365 days, and more than half the year is 183 days. (A
leap year has 366 days, and more than half a leap year is 184 days.)
Multiple support agreement

Sometimes no one person provides more than half the support for an individual. Instead, two or
more persons together provide more than half the individual' s support; each of these persons
would be able to take the exemption credit except for the support test. When this happens, those
providing the support, can agree that either one of them who individually provides more than 10
percent of the person'
s support can take an exemption for that person.
Noncustodial parent
The parent who has custody of a child for the greater part of the year is the child' s custodial
parent. The noncustodial parent is the parent who is not the custodial parent. A child is treated as
the qualifying child or qualifying relative of the noncustodial parent if all of the following
conditions are met:
• The child' s parents are divorced, legally separated, or lived apart at all times during the
last six months of the year.
• Parents who are married or who have never married each other lived apart at all times
during the last six months of the year.
• The child remained in the custody of one or both parents for more than half the year
28
• The child received more than half his or her own support during the calendar year from
his or her parents.
• Either of the following applies, as provided in a decree of divorce or legal separation or a
written separation agreement that applies, to the tax year at issue:
o The noncustodial parent is entitled to the dependent exemption for the child, or
o The custodial parent signed a written statement that he or she will not claim the
dependent exemption for the child. The custodial parent may sign federal Form
8332, Release of Claim of Exemption for Child of Divorced or Separated Parents,
or a similar statement. The noncustodial parent must attach a copy of the written
statement to his or her return.
If either of the above provisions was contained in a pre-1985 decree or agreement, the
noncustodial parent must have provided more than $600 in support for the child
during the year.
The noncustodial parent qualifies for the dependent exemption for a child who is treated as his or
her qualifying child or qualifying relative under the conditions set forth above. However, the
noncustodial parent does not qualify for head of household filing status.
Parent (father or mother)

If the taxpayer was unmarried and if the qualifying person is the parent, the taxpayer may be
eligible for the head of household filing status even if the father or mother did not live with the
taxpayer. However, your parent must have been a citizen or national of the U.S., or a resident of
the U.S. Canada, or Mexico. The taxpayer must be able to claim a dependent exemption for the
parent. The parent must meet the requirements of a qualifying relative.
Qualifying child
A qualifying child is a person who meets all of the following tests:
• Relationship test. The person must be one of the relatives listed below.
Adopted child Birth child Half brother Half sister Eligible foster child
Stepchild Grandchild Nephew Niece
Brother Sister Stepbrother Stepsister
• Age test. The person must be under 19 years of age or a full-time student under 24 years
of age. The person also meets the age test if he or she is permanently and totally disabled
at any time during the calendar year. If the person does not meet the age test to be a
qualifying child, he or she may meet the requirements to be a qualifying relative.
• Residency test. The person must live with you for more than half the year.
• Support test. The person must not have provided more than half of his or her own
support.
• Special test for qualifying child of more than one person. If a parent of one or more
taxpayers claim the same person as a qualifying child for a particular tax year, the person
shall be treated as the qualifying child of the taxpayer who is:
o The parent of the person,
o If none of the taxpayers is a parent, the taxpayer with the highest adjusted gross
income for the taxable year.
29
• If the parents do not file a joint income tax return together, their child shall be the
qualifying child of:
o The parent with whom the child resided for the greater number of days during the
taxable year, or
o If the child resides with both parents for the same number of days during the
taxable year, the parent with the highest adjusted gross income.
Qualifying person
The taxpayer must have a qualifying person to qualify for the head of household filing status.
The qualifying person must be either a qualifying child or qualifying relative and the taxpayer
must pay more than half the cost of keeping up the home in which the taxpayer and the
qualifying child or qualifying relative lived for more than half the year.
Qualifying relative
A qualifying relative is a person who meets all of the following tests:
• Not a qualifying child test. The person must not meet the requirements to be your
qualifying child or the qualifying child of anyone else.
• Relationship or member of the household test.
1 The person must be one of the relatives listed below.
2 If at any time during the year the person was your spouse, the person cannot qualify as
your dependent, and you are not entitled to claim a dependent exemption for the person.
Any of the relationships listed that were established when the taxpayer married, are not
ended if the taxpayer divorces or his or her spouse dies.
A person who is not one of the relatives listed cannot qualify you for the head of
household filing status. Under no circumstances shall the same person be used to qualify
more than one taxpayer for the head of household filing status for the same year.
Stepchild Parent Grandparent Uncle Aunt

Birth child
Adopted
Grandchild Stepfather Stepmother Nephew Niece
child
Brother Sister Son-in-law Daughter-in- Eligible
law foster child
Brother-in-
Half Brother Half sister Sister-in-law
law
Father-in- Mother-in-
Stepbrother Stepsister
law law
(1) Any unrelated person who lived with the taxpayer all year as a member of the
household can also be the qualifying person for head of household filing status. Cousins
are descendants of a brother or sister of the parents and do not qualify under the
relationship test as relatives.
30
2008 Pub 17
(2) An uncle or aunt may qualify only if he or she is
the brother or sister of the taxpayer’s father or
mother.
(3) A nephew or niece may qualify only if he or she

is the child of the taxpayer’s brother or sister.
• Gross income test. The taxpayer may not
take an exemption for a dependent if that
person had gross income equal to or more
than the federal allowable dependent
exemption amount for that particular year.
• Support test. The taxpayer must provide
more than half of a person' s total support
during the calendar year to meet the support
test.
Temporary absence
Temporary absences include those due to illness,
education, business, vacations, military service,
and, in some cases, incarceration. Time the qualifying person was in the custody of another
person under either a formal or informal custody agreement is not a temporary absence.
Dependent Exemptions
U.S. citizen or resident alien. If the taxpayer is a U.S. citizen, U.S. resident alien, U.S. national or
a resident of Canada or Mexico, the taxpayer may qualify for any of the exemptions discussed
here.
Nonresident aliens. Generally, if the taxpayer is a nonresident alien (other than a resident of
Canada or Mexico, or certain residents of India or Korea), the taxpayer can qualify for only one
personal exemption for himself. The taxpayer cannot claim exemptions for a spouse or
dependents.
Personal Exemption
The taxpayer can take one exemption for himself unless they can be claimed as a dependent by
another taxpayer.
The spouse is never considered your dependent.

Exemptions for Dependents
The taxpayer is allowed one exemption for each person they can claim as a dependent. They can
claim an exemption for a dependent even if the dependent files a return.
The term “dependent” means:
A qualifying child, or
A qualifying relative.
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The taxpayer can claim an exemption for a qualifying child or qualifying relative only if these
three tests are met.
1. Dependent taxpayer test.
2. Joint return test.
3. Citizen or resident test.
Child
There are five tests that must be met for a child to be the qualifying
child. The five tests are:
Relationship, Age, Residency, Support, and
Special test for qualifying child of more than one person.
Relationship Test
To meet this test, a child must be: a son, daughter, stepchild, eligible foster child, or a descendant
(for example, your grandchild) of any of them, or a brother, sister, half brother, half sister,
stepbrother, stepsister, or a descendant (for example, your niece or nephew) of any of them.
Adopted child. An adopted child is always treated as the taxpayer’s own child. The term
“adopted child” includes a child who was lawfully placed with you for legal adoption.
Eligible foster child. An eligible foster child is an individual who is placed with you by an
authorized placement agency or by judgment, decree, or other order of any court of competent
jurisdiction.
Age Test
To meet this test, a child must be:
Under age 19 at the end of the year,
A full-time student under age 24 at the end of the year, or
Permanently and totally disabled at any time during the year, regardless of age.
Full-time student. A full-time student is a student who is enrolled for the number of hours or
courses the school considers to be full-time attendance.
Permanently and totally disabled. The child is permanently and totally disabled if both of the
following apply.
He or she cannot engage in any substantial gainful activity because of a physical or mental
condition.
A doctor determines the condition has lasted, or can be expected to last, continuously for at least
a year or can lead to death.
Residency Test
To meet this test, the child must have lived with the taxpayer for more than half of the year.
There are exceptions for temporary absences, children who were born or died during the year,
kidnapped children, and children of divorced or separated parents.
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Temporary absences. The child is considered to have lived with the taxpayer during periods of
time when temporarily absent due to special circumstances such as:
• Illness,
• Education,
• Business,
• Vacation, or
• Military service.
Birth or Death of a child. A child who was born or died during the year is treated as having
lived with the taxpayer all year if the home was the child' s home the entire time he or she was
alive during the year. The same is true if the child lived with the taxpayer all year except for any
required hospital stay following birth.
Children of divorced or separated parents. In most cases, because of the residency test, a child
of divorced or separated parents is the qualifying child of the custodial parent. However, the
child will be treated as the qualifying child of the noncustodial parent if all four of the following
statements are true.
1. The parents:
a. Are divorced or legally separated under a decree of divorce or separate
maintenance,
b. Are separated under a written separation agreement, or
c. Lived apart at all times during the last 6 months of the year.
2. The child received over half of his or her support for the year from the parents.
3. The child is in the custody of one or both parents for more than half of the year.
4. Either of the following statements is true.
a. The custodial parent signs a written declaration, discussed later, that he or she will
not claim the child as a dependent for the year, and the noncustodial parent
attaches this written declaration to his or her return. (If the decree or agreement
went into effect after 1984, see Divorce decree or separation agreement made
after 1984, later.)
b. A pre-1985 decree of divorce or separate maintenance or written separation
agreement that applies to 2008 states that the noncustodial parent can claim the
child as a dependent, the decree or agreement was not changed after 1984 to say
the noncustodial parent cannot claim the child as a dependent, and the
noncustodial parent provides at least $600 for the child's support during the year.
Custodial parent and noncustodial parent. The custodial parent is the parent with whom the
child lived for the greater part of the year. The other parent is the noncustodial parent.
If the parents divorced or separated during the year and the child lived with both parents before
the separation, the custodial parent is the one with whom the child lived for the greater part of
the rest of the year.
Written declaration. The custodial parent may use either Form 8332 or a similar statement
(containing the same information required by the form) to make the written declaration to release
the exemption to the noncustodial parent. The noncustodial parent must attach the form or
statement to his or her tax return.
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The exemption can be released for 1 year, for a number of specified years (for example, alternate
years), or for all future years, as specified in the declaration. If the exemption is released for
more than 1 year, the original release must be attached to the return of the noncustodial parent
for the first year, and a copy must be attached for each later year.
Divorce decree or separation agreement made after 1984. If the divorce decree or separation
agreement went into effect after 1984, the noncustodial parent can attach certain pages from the
decree or agreement instead of Form 8332. To be able to do this, the decree or agreement must
state all three of the following.
1. The noncustodial parent can claim the child as a dependent without regard to any
condition, such as payment of support.
2. The custodial parent will not claim the child as a dependent for the year.
3. The years for which the noncustodial parent, rather than the custodial parent, can claim
the child as a dependent.
The noncustodial parent must attach all of the following pages of the decree or agreement to his
or her tax return.
• The cover page (write the other parent' s social security number on this page).
• The pages that include all of the information identified in items (1) through (3) above.
• The signature page with the other parent' s signature and the date of the agreement.
The noncustodial parent must attach the required information even if it was filed with
a return in an earlier year.
Support Test (To Be a Qualifying Child)

To meet this test, the child cannot have provided more than half of his or her own support for the
year. A scholarship received by a child who is a full-time student is not taken into account in
determining whether the child provided more than half of his or her own support.
Refer to Pub 17 for more information
California Exemption Credits

Unlike the federal return the CA exemption is a nonrefundable credit.
There are three types of exemptions; Personal exemptions, blind exemption, and dependent
exemptions. See the California Chapter in this syllabus for more information.
34
Chapter 2 Questions (38 through 60)
38. Which of the following is true regarding filing status?

A. The marital status on the last day of the year determines the filing status for the
entire year.
B. To qualify for head of household status, the taxpayer must be unmarried and
must have paid more than half the cost of maintaining a household that was the
main home for a qualifying person for more than half the year.
C. The taxpayer may be able to file as a qualifying widow or widower for the two
years following the year the spouse died.
D. All of the above
39. The IRS requires Same Sex Married Couples to file as married filing jointly or married
filing separately.
A. True
B. False
40. The taxpayer may be able to file as a qualifying widow or widower for the two years
following the year the spouse died. To do this, the taxpayer must meet all four of the
following tests, except?
A. The taxpayer is entitled to file a joint return with the spouse for the year he or she
died. It does not matter whether the joint return was actually filed,
B. The taxpayer did not remarry in the two years following the year the spouse died,
C. There is a child, stepchild, or adopted child (a foster child does not meet this
requirement) for whom the taxpayer can claim a dependency exemption,
D. The child does not have to be a dependent if in the military
E. The taxpayer paid more than half the cost of maintaining a household that was the
main home for them and that child, for the whole year.
41. What California form or publication describes the rules which apply to filing status?
A. 1051A
B. 1001
C. 3885
D. 3801
42. Which of the following items related to Married Filing Separate filing status is incorrect?
A. The taxpayer cannot take the child and dependent care expenses in most cases.
See Form 2441 for more information.
B. The taxpayer cannot take the earned income credit.
C. The taxpayer cannot take the exclusion or the credit for adoption expenses in most
cases.
D. The taxpayer can take the education credits or student loan interest
35
43. In respect to Married Filing Separately, which of the following is true if the taxpayer
lived with the spouse at any time during the tax year?
A. The taxpayer cannot claim the credit for the elderly or the disabled
B. The taxpayer will have to include in income more (up to 85%) of any social
security income or equivalent railroad retirement benefits received.
C. The taxpayer cannot rollover amounts from a traditional IRA to a Roth IRA
D. All of the above
44. Which of the following is not a community property state?

A. Arizona
B. California
C. New Mexico
D. New York
45. Community income must be split between the taxpayer and spouse equally when filing
separate returns. Community status ends when marital partners physically separate with
no immediate intention of reconciliation.
A. True
B. False
46. Which of the following is not a definition of separate property in a community property
state?
A. Property owned separately by a spouse before marriage
B. Property received by both the taxpayer and spouse as gifts or inheritances.
C. Money earned while domiciled in separate property states
D. All property declared separate property in a valid agreement (pre-or-post nuptial)
47. Which of the following is not true regarding separate property in a community property
state?
A. Separate property belongs to the spouse who owns it
B. The taxpayer must maintain the property separately
C. The taxpayer can commingle the separate property with the spouse
48. For California and the federal return which of the following are qualifications for the
head of household filing status?
A. The spouse did not live in the taxpayer’s home at any time during the last six
months of the taxable year.
B. The home was the main home for the taxpayer and the birth child, stepchild,
adopted child, or eligible foster child for more than half the year.
C. The taxpayer must be entitled to claim a dependent exemption for the child. The
child must meet the requirements to be either a qualifying child or qualifying
relative and meet the joint return and citizenship tests.
D. All of the above
36
49. An eligible foster child is a child placed with the taxpayer by an authorized placement
agency or by a judgment, decree, or other order of a court of competent jurisdiction.
Generally, formal placement ends when the child reaches the age of 19.
A. True
B. False
50. To qualify for head of household filing status, the eligible foster child must meet the
requirements of a __________________________.
A. Qualifying child and qualifying parent
B. Qualifying child or a qualifying relative
C. Qualifying adult and qualifying parent
D. Qualifying niece and qualifying nephew
51. Generally, if two or more people keep up the same home, _________________ could pay
more than half the costs and qualify for the head of household filing status.
A. Both people
B. Only one of the people
C. Neither of the above
D. Both of the above
52. In a multiple support agreement those providing the support can agree that either one of
them who individually provides _________________ of the person' s support can take an
exemption for that person.
A. More than 10 percent
B. More than 15 percent
C. More than 20 percent
D. More than 5 percent
53. Which of the following qualifies as the time to claim head of household filing status that
a child must live with a custodial parent?
A. More than 5 months
B. More than half the year (more than 183 days)
C. More than 4 months
D. More than 3 months
54. Under which is not a condition that qualifies a noncustodial parent claim the exemption
for their child?
A. The child' s parents are divorced, legally separated, or lived apart at all times
during the last six months of the year.
B. Parents who are married or who have never married each other lived apart at all
times during the last six months of the year.
C. The child remained in the custody of one or both parents for more than half the
year
D. The child earned more than half his or her own support during the calendar year.
37
55. Form 8332 is which of the following?
A. Release of Claim of Exemption for Child of Divorced or Separated Parents
B. Depreciation and Amortization
C. Sale of Business Property
D. Moving Expenses
56. If the taxpayer was unmarried and if the qualifying person is the parent, the taxpayer may
be eligible for the _______________________ even if the father or mother did not live
with the taxpayer.
A. Head of household filing status
B. Married filing separate filing status
C. Single filing status
D. None of the above
57. Which of the following is not a test for qualifying child

A. Residency
B. Relationship
C. Age
D. Income
58. If the taxpayer is a U.S. citizen, U.S. resident alien, U.S. national or a resident of Canada
or Mexico, the taxpayer may qualify for any of the dependent exemptions discussed here.
A. True
B. False
59. Which of the following is a definition of an eligible foster child?

A. A child who was lawfully placed with you for legal adoption
B. An individual who is placed with you by an authorized placement agency or by
judgment, decree, or other order of any court of competent jurisdiction.
C. An individual enrolled for the number of hours or courses the school considers to
be full-time attendance.
D. The child is permanently and totally disabled
60. A scholarship received by a child who is a full-time student is taken into account in
determining whether the child provided more than half of his or her own support.
A. True
B. False
38
Chapter 3 - Wages and 1099’s
Income from 1099's and W-2's
Form Title What to Report Amounts to Due Date to Due Date to

Report IRS Recipient)
1098 Mortgage Interest Mortgage interest (including points) $600 or more February 28 (To
Statement you received in the course of your Payer/Borrower)
trade or business from individuals January 31
and reimbursements of overpaid
interest.
1098-E Student Loan Student loan interest received in the $600 or more February 28 January 31
Interest Statement course of your trade or business.
1098-T Tuition Payments Qualified tuition and related See February 28 January 31
Statement expenses, reimbursements or instructions
refunds, and scholarships or grants
(optional).
1099-A Acquisition or Information about the acquisition or All amounts February 28 (To borrower)
Abandonment of abandonment of property that is January 31
Secured Property security for a debt for which you are Pub 4681
lender.
1099-B Proceeds from Sales or redemptions of securities, All amounts February 28 January 31
Broker and Barter futures transactions, commodities,
Exchange and barter exchange transactions. Pub 525
Transactions
1099-C Cancellation of Cancellation of a debt owed to a $600 or more February 28 January 31

Debt financial institution, the Federal
government, a credit union, RTC,
FDIC, NCUA, a military department,
the U.S. Postal Service, the Postal Pub 4681
Rate Commission, or any
organization having a significant
trade or business of lending money.
1099-Div Dividends and Distributions, such as dividends, $10 or more, February 28 January 31
Distributions capital gain distributions, or except $600 or
nontaxable distributions, that were more for
paid on stock, and liquidation liquidations
distributions.
1099-G Certain Unemployment compensation, state Any amount for February 28 January 31
Government and and local income tax refunds, a QSTP; $10
Qualified State agricultural payments, taxable or more for
Tuition Program grants, and earnings from a qualified refunds and
Payments state tuition program (QSTP). unemployment;
$600 or more
for all others.
39
1099-INT Interest Income Interest Income. $10 or more February 28 January 31
1099- Long Term Care Payments under a long term care All amounts February 28 January 31
LTC and Accelerated insurance contract and accelerated
Death Benefits death benefits paid under a life Pub 525
insurance contract or by a viatical
settlement provider.
1099- Miscellaneous Rent or royalty payments; prizes or $600 or more, February 28 January 31
MISC Income (Also, use awards that are not for services, except $10 or
this form to report such as winnings on TV or radio more for
the occurrence of shows. royalties
direct sales of
$5000 or more of Payments to crew-members by All amounts
consumer goods owners or operators of fishing boats
for resale.) including payments of proceed from
sale of catch.
Payments to a physician, physician's $600 or more

corporation, or other supplier of
health or medical services. Issued
mainly by medical assistance
programs or health and accident
insurance plans.
Payments for services performed for $600 or more

a trade or business by people not
treated as its employees. Example:
fees to subcontractors or directors,
and golden parachute payments.
Fish purchases paid in cash for $600 or more

resale.
Substitute dividend and tax-exempt $10 or more

interest payments reportable by
brokers
Crop Insurance proceeds $600 or more
Gross Proceeds paid to attorneys All amounts
1099- Distributions From Distributions from a medical savings All amounts February 28 January 31
MSA an MSA or account (MSA) or Medicare+Choice
Medicare+Choice MSA
MSA
1099- Original Issue Original Issue Discount $10 or more February 28 January 31
OID Discount
1099- Taxable Distributions from cooperatives to $10 or more February 28 January 31

PATR Distributions their patrons.
40
1099-R Distributions From Distributions from retirement or $10 or more February 28 January 31
Pensions, profit-sharing plans, any IRA, or
Annuities, insurance contracts, and IRA
Retirement or recharacterizations.
profit-sharing
Plans, IRAs,
Insurance
Contracts, Etc.
1099-S Proceeds From Gross proceeds from the sale or Generally, February 28 January 31
Real Estate exchange of real estate $600 or more
Transactions
5498 IRA Contribution Contributions (including rollover All amounts May 31 (To Participant)
Information contributions) to any Individual For value of
retirement arrangement (IRA) account and for
including SEP, SIMPLE, Roth IRA, education IRA
and Ed IRA; Roth conversions; IRA contributions,
recharacterizations; and the fair January 31; for all
market value of the account. other
contributions, May
31
5498- MSA or Contributions to a medical savings All amounts May 31 (To Participant)
MSA Medicare+Choice account (MSA) and the fair market May 31
MSA Information value of an MSA or
Medicare+Choice MSA.
W-2G Certain Gambling Gambling winnings from horse Generally, February 28 January 31
Winnings racing, dog racing, jai alai, lotteries, $600 or more;
keno, bingo, slot machines, $1,200 or more
sweepstakes, wagering pools, etc. from bingo or
slot machines;
$1,500 or more
from keno
W-2 Wage and Tax Wages, tips, other compensation; See separate To SSA January 31
Statement social security, Medicare, withheld Instructions Last day of
income taxes; and advance earned February
income credit (EIC) payments.
Include bonuses, vacation
allowances, severance pay, certain
moving expense payments, some
kinds of travel allowances, and third-
party payments of sick pay.
41
42
43
Employee Compensation
Line 7 of Form 1040 - Wages, Salaries and Tips - (2008, 1040)
Wages, salaries and tips reported on Form W-2, Box 1 are
reported on Line 7 of Form 1040. If a joint return the spouse'
s
income is also included.
The items here are excerpts from Line 7 of Form 1040 for 2008
Refer to Pub 17, Part I, Chapter 4 for information on completing
Form’s W-2 and W-4.
44
The following was taken from the 2008 1099R instructions in reference to Box 7.
1. Early distributions, no known exception (in most cases, under 59 1//2).
2. Early distribution, exception applies
3. Disability
4. Death
5. Prohibition transaction
6. Section 1035 exchange (a tax free exchange of life insurance, annuity or endowment
contracts)
7. Normal distribution
8. Excess contributions plus earnings/excess deferrals taxable in 2008
9. Cost of current life insurance protection
A. May be eligible for 10-year tax option (Form 4972)
B. Designated Roth account distribution
C. N/A
D. Excess contributions plus earnings/excess deferrals in 2008
E. Excess annual deductions under Section 415 and certain excess amounts under Section
403(b) plans
F. Charitable gift annuity
G. Direct rollover to a qualified plan, tax-shelter annuity, a governmental 457 (b) plan or an IRA
H. N/A
I. N/A
J. Early distribution from a Roth IRA, no known exceptions
K. N/A
L. Loans treated as deemed distributions under section 72(p).
M. N/A
N. Recharacterized IRA contribution made for 2008.
O. N/A
P. Excess contributions plus earnings/excess deferrals in 2008
Q. Qualified distribution from a Roth IRA
R. Recharacterized IRA contribution made in 2008.
S. Early distribution from a SIMPLE IRA the first 2 years, no known exception
T. Roth IRA distribution, exception applies
Statutory employees
Box 13 of Form W-2 should be checked. Statutory employees include full-time life insurance
salespeople, certain agent or commission drivers and traveling sales people and certain home workers.
The amount reported in Box 1 is not shown on Line 7 of Form 1040 but is entered as income on
Schedule C. Statutory employees are not subject to self-employment tax.
Miscellaneous Compensation
Child-care providers, either in the taxpayer'
s home, the child'
s home, or another location, the pay must
be included in income. If someone else does not employ the childcare provider, the provider is probably
self-employed and must report the income on Schedule C. The same rule applies to babysitting as
childcare.
45
Advanced commissions received for services to be performed in the future, a cash taxpayer must report
the income in the year received.
Back pay awards are reported on a W-2 and entered on Line 7 of Form 1040.
Bonuses or awards received for outstanding work are included in income and reported on Form 1040,
line 7. Prizes such as vacation trips for meeting sales goals or awards in the form of goods or services
are taxable at the fair market value.
Stock appreciation rights granted by the employer are not included in income until they are exercised
(use the right). When the right is used a cash payment equal to the fair market value of the corporation’s
stock on the date of use minus the fair market value on the date the right was granted is included in
income in the year the right is used.
Non-statutory options to buy or sell stock or other property as payment for services, there will be
income either when the option is received or exercised (used to buy or sell other stock or other
property). The employer determines which type of option. (Refer to Pub 525).
Life Insurance Proceeds
Refer to “Life Insurance Proceeds” in Pub 525 for
the taxable portion when the value of the proceeds
exceed the value at the date of death or when paid
in installments.
Fringe Benefits
Fringe benefits received in connection with the performance of the services
performed are included in income as compensation, usually not in the form of cash.
They are not included in income if they are purchased at the fair market value or are
specifically excluded by law.
The value of accident and health plan benefits are generally not included in income, benefits from the
plan may be taxable. Long-term care coverage contributions by the employer are generally not taxable.
However, contributions made through a flexible spending or other similar arrangement must be included
in income. This amount is usually included in Box 1 of form W-2 as wages.
Archer MSA contributions made by the employer are not included in income. The total is included in
Box 12 of W-2 with a code R.
Deminimis benefits or a gift provided by the employer that is a product or service of minimal value is
not included in income. However, if the employer gives a gift certificate or similar item that can be
easily exchanged for cash the value of the gift should be included in salary or wages, regardless of the
amount.
46
No additional cost fringe benefits are those benefits offered to the taxpayer that are of no additional
cost to the employer, or a service that is offered for sale to customers in the ordinary course of doing
business. These benefits are not taxable.
Qualified discounts on the purchase of the employer' s goods or services are not taxable if the discount
received is not greater than the gross profit percentage of the price the product is offered to the general
public. The discount also cannot exceed 20% of the price at which the goods are offered to the public.
The discount must be offered to all employees.
Working condition fringe benefits are excluded from tax by the employee if it would have been
deductible as an employee business expense if the employee had paid the amount out-of pocket.
Educational assistance of qualified employer provided educational assistance is required. The

exclusion applies to undergraduate and graduate level courses. If the education is not required by the
employer or the law, it can be qualifying work-related education only if it maintains or improves skills
needed in the taxpayer’s present work.
Employer-provided vehicles are usually taxable non-cash fringe benefits. The employer must
determine the actual value of this fringe benefit to include in income.
A transportation fringe benefit can be excluded from income up to certain limits. A qualified
transportation fringe benefit is:
• Commuter highway vehicle between home and work, or
• A transit pass, or
• Qualified parking
Cash reimbursement by the employer for these expenses under a bona fide reimbursement arrangement
is also excludable. There is a $100 exclusion limit for commuter vehicle and transit pass and a $190 a
month exclusion limit for parking, regardless of the value.
Qualified moving expense reimbursements under a qualified plan may be excluded from income if the
expenses are a deductible moving expense. If a nonqualified plan, the amount is included in income.
(Refer to Form 3903)
The cost of group term-life insurance is excludable from income if the coverage is less than $50,000.
The cost of the employer provided insurance over $50,000 is included in income. If the taxpayer pays
any portion of the premium the taxable portion is reduced dollar for dollar.
Scholarships or fellowships to someone who is a degree candidate is excluded from income, if the
scholarship is used for tuitions, fees, books, supplies or equipment required by the financial
institution.
Clergy and Military

A member of the clergy must include in income offerings and fees received for marriages,
baptisms, funerals, masses, etc. in addition to the salary unless the offering or fee is to the
religious organization. If the clergy donates offerings or fees received by the clergy to the religious
47
institution it is still taxable to the clergy, but the clergy can take a charitable contribution deduction.
Special rules apply for housing of the clergy. The rental value of the home or housing allowance is not
included in income. The housing allowance is subject to self-employment tax; refer to Schedule SE or
Publication 517.
U.S. citizens working for a foreign government, an international organization, a foreign embassy or
any foreign employer the income is included as salary. The wages are usually excluded from social
security and Medicare taxes, but the income is subject to self-employment taxes.
Payments received as a member of the military are generally taxable as wages except for retirement
pay, which is taxed as a pension. Allowances are generally not taxed. Military retirement pay based on
age or length of service is generally taxable. Do not include any reduction in retirement or retainer pay
to provide a survivor annuity for the spouse or children under the Retired Serviceman’s Family
Protection Plan or the Survivor Benefit Plan.
Do not include in income any veteran's benefits paid under any law, regulation or administrative
practice administered by the Department of Veterans Affairs. The following amounts are not taxable:
• Education, training and subsistence allowances
• Disability compensation and pension payments for disabilities paid either to veterans or their
families
• Grants for homes designed for wheelchair living
• Grants for motor vehicles for veterans who lost their sight or use of their limbs
• Veterans'insurance proceeds and dividends paid either to veterans or their beneficiaries,
including the proceeds of a veteran'
s endowment policy paid before death
• Interest on insurance dividend left on deposit with the VA
VA payments to hospital patients and resident veterans for their services under VA therapeutic or
rehabilitative programs are not treated as nontaxable veteran'
s benefits. Report these payments as
income on line 21 of Form 1040.
Volunteer workers for the Peace Corps receiving living allowances are exempt from tax. Taxable
allowances included below are reported as wages:
• Allowances paid to the spouse or minor children while volunteer leader training in the United
States
• Living allowances designated by the Director of the Peace Corps as basic compensation.
These are allowances for personal items such as domestic help, laundry and clothing
maintenance, entertainment and recreation, transportation, and other miscellaneous expenses
• Leave allowances
• Readjustment allowances or termination payments. These are considered received when
credited to the account
•
Employee Benefits
Sick pay is a payment to replace regular wages while temporarily absent from work due
to sickness or personal injury. To qualify as sick pay, it must be paid under a plan to
which the employer is a party. Sick pay is taxable and subject to withholding when paid by the
48
employer. If the sick pay is paid by a third party where the employer is not a party, the sick pay is
generally not taxable.
Health insurance coverage provided by the employer is usually not included as income. The insurance
premiums would not be a Schedule A deduction, unless self-employed health insurance.
Disability Insurance Benefits are taxable depending on who paid the premiums. If the employee pays
the premium, the premium is not a qualified medical expense and is not deductible. The benefits
received are excluded from income.
Employer-paid premiums are deductible as employee benefits. The premiums are not included in taxable
income of the employee. However, benefits from an employer-paid disability policy are generally
taxable to employees to the extent the amounts exceed qualified medical expenses for the current year.
Cafeteria Plans (or flexible benefit plan) allows employees to choose between receiving taxable
compensation and funding one or more tax-free benefits. The employer for the benefit of the employees
must maintain the plan; the plan must be written; the plan must be available to all employees; and the
plan must include two or more benefits consisting of cash and qualified benefits.
• Qualifying benefits include

• Group term-life insurance premium costs
• Disability income and accident insurance costs
• Health insurance premium costs
• Dental insurance premium costs
• Medical costs not covered by insurance
• Qualified dependent care benefits
• Qualified transportation costs
• Contribution to qualified 401(k)-pension plan
Workers’ Compensation
Amounts received as workers’ compensation for an occupational sickness or injury are fully
exempt from tax, the exemption does not apply to retirement plans based on age, length
of service or prior contributions. The following compensation received for injury or
sicknesses are not taxable:
• Compensatory damages received for physical injury or sickness, whether paid in a lump sum
or in periodic payments
• Benefits received under an accident or health insurance policy on which either the taxpayer
or the employer paid the premiums that were included in income
• Compensation received for permanent loss or loss of a part or function of the body, or for
permanent disfigurement. This compensation must be based only on the injury and not on the
period of absence from work. These benefits are not taxable even if the employer pays for the
accident and health plan that provides these benefits
49
Foreign Income Exclusion
Qualified individuals may elect to exclude up to $87,600 of foreign earned income from taxable income,
if both spouses work in a foreign country and meet the qualifications for the exclusion, up to $175,200
can be excluded. The exclusion increases based on cost of living adjustments (COLA).
An individual generally qualifies if his/her tax home is in a foreign country and one of the following
tests is met:
1. Bona Fide resident test is met when an individual is in a foreign country for an uninterrupted period
of time that includes the entire year.
2. The physical presence test is met if an individual is in a foreign country or countries 330 days during
a period of 12 consecutive months. Days of travel between countries qualify as full days.
Foreign earned income includes:

• Salaries and wages
• Allowances for housing and other expenses
• Business profits, royalties or rents tied to the performance of services
• Value of fringe benefits
An exclusion is also allowed for housing. Foreign taxes paid on excluded income do not qualify for the
foreign tax credit (Form 1116). Report the Foreign Earned Income on Form 2555. (Refer to Pub 54)
50
61. Which of the following 1099'
s should include rental income?
A. 1099-MISC
B. 1099-C
C. 1099-S
62. Which of the following is not reported on a 1099-MISC?

A. Miscellaneous Income
B. Rents or royalties, prizes not for services
C. Nonemployee compensation
D. Distributions from a MSA
63. Distributions from IRA'

s pensions and annuities are reported on Form 1099-R
A. True
B. False
64. Employee compensation is reported on Line 7 of Form 1040.

A. True
B. False
65. Which of the following items are not reported on a W-2?

A. Dependent care benefits paid or incurred by the employer
B. Excess salary deferrals
C. MSA Contributions
D. Pension and annuity income
66. Which of the following items are found on a W-2?

A. Uncollected Social Security tax on tips
B. Cost of group life insurance coverage over $50,000
C. Employer payments on the adoption assistance program
D. All of the above
67. Where are the dependent care benefits the employer paid to the taxpayer or incurred on behalf of the
taxpayer found?
A. W- 2, Box 10
B. 1099-MISC
C. 1099-DCB
68. Box 12 on Form W-2 report elective deferrals and other more common items that must be reported.
A. True
B. False
51
69. Which of the following are not true about statutory employees?
A. Box 13 of the W-2 should be checked.
B. Full-time life insurance salespeople can qualify as a statutory employee
C. The wages shown in Box 1 of form W-2 is reported as income on Schedule C
D. Statutory employee income is subject to self- employment tax.
70. Fringe benefits received in connection with the performance of the services performed are included
in income as compensation, unless purchased at the fair market value or specifically excluded by
law.
A. True
B. False
71. A cash basis taxpayer must report an advanced commission received for services to be performed in
the future:
A. In the tax year the service is actually performed
B. In the tax year the income is received
C. The tax year after the advance commission is received
D. Never
72. Bonuses or awards received for outstanding work are:

A. Reported as an adjustment to income
B. Reported on Schedule A as a deduction to income
C. Included in income and reported on Form 1040, line 7
73. Stock appreciation rights granted by the employer are included in income when exercised.
A. True
B. False
74. Which of the following payments received as a member of the military are not generally taxable?
A. Wages except for retirement pay.
B. Allowances.
C. Military retirement pay based on age or length of service.
75. Employees can exclude working condition fringe benefits from tax if it would have been deductible
as an employee business expense.
A. True
B. False
76. Which of the following is not true regarding tax on the clergy?
A. Offerings and fees from marriages must be included in income.
B. If the clergy donates the fees from a marriage to the religious organization it is still taxable.
C. The rental value of the housing for the clergy is not included in income.
D. Clergy cannot take a charitable deduction for their donations.
77. Scholarships or fellowships to someone who is a degree candidate is excluded from income, if the
52
scholarship is used for tuitions, fees, books, supplies or equipment required by the financial
institution.
A. True
B. False
78. Sick pay is a payment to replace wages while temporarily absent from work due to sickness. Sick
pay is taxable if paid by the employer.
A. True
B. False
79. Amounts received as _______ for an occupational sickness or injuries are fully exempt from tax.
A. Self-employed
B. Retirement pay
C. Workers’compensation
D. Wage earner
80. Which of the following is incorrect regarding the Foreign Income Exclusion?
A. Compute the foreign income exclusion on Form 2555.
B. Qualified individual may elect to exclude up to $87,600 of foreign earned income from taxable
income.
C. Salaries and wages are never included as foreign earned income
D. The value of fringe benefits are included in foreign earned income
53
Chapter 4 - Interest and Dividends
Interest Income
Taxable interest includes interest received from bank accounts, certificate of deposits, loans
to others and other sources. The following are sources of taxable interest:
1. Dividends that are actually interest must be reported as interest on accounts in:
Cooperative banks
Credit Unions
Domestic building and loan associations
Domestic savings and loan associations
Federal savings and loan associations
Mutual savings banks
2. Money market certificates, savings certificates and other deferred interest accounts.
3. Interest subject to penalty for early withdrawal – report the full amount of interest without
subtracting the penalty on early withdrawal.
4. Gifts for opening an account - Gifts or services for deposits less than $5,000 valued at more than $10
or for deposits of $5,000 or more valued at $20 or more must be reported as interest. The value is
determined by the financial institution and included on Form 1099-INT.
5. Interest on insurance dividends is taxable in the year the interest is received.
6. Interest on U.S. obligations is taxable for federal income tax purposes.
7. Municipal bonds or interest on obligations used to finance government is not taxable if issued by a
state, the District of Columbia, a U.S. possession or any of their subdivisions.
8. Treasury Bills generally have a 4-week, 13-week, or 26-week maturity period. They are issued at a
discount in the amount of $1,000 and multiples of $1,000. The difference between the discounted
price paid for the bills and the face value received at maturity is interest income. The interest is
generally reported at maturity.
9. Money market interest is taxable in the year it is received or credited to the taxpayers account and
can be withdrawn without substantial penalty. Interest on the money market account is not taxable if
the interest is not credited to the taxpayer' s account until maturity and withdrawal or redemption
would result in a substantial penalty.
10. OID - When a long-term debt instrument is issued at a price that is lower than its stated redemption
value, the difference is called original issue discount (OID). Interest is reported on 1099-OID.
Adjustments are sometimes needed for OID interest because the issuing company does not track the
activity of the bond.
11. The interest from a bearer and coupon bond is taxable the year the bonds are due and payable
regardless of when they are presented for collection.
12. Interest paid on money borrowed to invest is a separate transaction from the money earned on the
investment. The interest paid on the money borrowed is deductible if the taxpayer itemizes. Report
investment interest expense on Form 4952.
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When to Report Interest
Interest is reported depending on the method of accounting. Most individuals use the cash method of
accounting. Generally under this method the interest is reported in the year it is actually or
constructively received. When interest is credited to an account or made available to the taxpayer it is
constructively received. If the taxpayer is using an accrual method of accounting the interest is taxable
when it is accrued, whether or not the taxpayer has received it.
How Interest is Reported to the Taxpayer?

Taxable interest is reported to the taxpayer on Form 1099-INT in Box 1 except for U.S. savings bonds
and Treasury obligations, and OID. All taxable interest must be reported whether or not Form 1099 is
received.
Which Form is used to Report Interest Income?

The taxpayer may only use Form 1040EZ if the interest income is less than $1,500.
If the taxpayer is filing form 1040 or 1040A, Schedule 1(1040A) or Schedule B (1040) must be
completed if any of the following are true:
1. Taxable interest income exceeds $1,500.
2. The taxpayer is claiming the interest exclusion under the education Savings Bond Program.
3. Seller-financed mortgage interest and the buyer used the property as a home.
4. The taxpayer received a 1099-INT for savings bond interest (Box 3).
5. The taxpayer received a 1099-INT for tax exempt interest.
6. The taxpayer received as a nominee interest that was reported by someone else.
If the taxpayer had interest from or authority over a foreign bank account they must file Form 1040 and
use Schedule B to report the interest.
Interest is considered nominee interest when the registered owner receives a 1099-INT with interest
income in his/her name, but the interest actually belongs to someone else. The full amount of interest
must be reported. On a separate line below the total of all interest reported label the nominee interest
received as "Nominee Distribution" and subtract it from the total.
Note: Form 1099-INT must be issued by the taxpayer claiming the nominee distribution to the actual
owner of the interest.
The Education Savings Bond Program allows interest received on Series EE Bonds issued after 1989
or a Series I Bond to a taxpayer over the age of 24 may exclude the interest income from that bond if
during the year the taxpayer paid qualified higher education expenses to an eligible educational
institution. Refer to Form 8815 for instructions and limitations.
Dividend Income
Dividends are distributions of money stock or other property paid to the taxpayer by a corporation.
Dividends may be received by a taxpayer through a partnership, an estate, a trust, or an association that
is taxed as a corporation. Ordinary dividends are the most common type of dividends and are paid out
of earnings and profits of a corporation. Ordinary dividends are reported on Form 1099-DIV box 1a.
Ordinary dividends that are not “qualified” are taxed as ordinary income.
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Qualified Dividends are the ordinary dividends that are subject to the same 0% or 15% maximum tax
rate that applies to net capital gain. They are shown in box 1b of Form 1099-DIV. The dividends must
have been paid by a U.S. Corporation or a qualified foreign corporation. The dividends must meet the
holding period.
Excerpt from 2008 Pub 17.
Ordinary dividend income that exceeds $1,500 must be

reported on Schedule 1 when filing Form 1040A and on
Schedule B when filing Form 1040. The amount from
Schedule B is carried to the 1040, line 9a. The qualified
dividends are reported on 9b. Qualified dividends are
carried to page 2 of Schedule D, line 23. If the total
interest and dividends are less than $1,500, Schedule B is
not required.
Ordinary dividends reinvested into stock through a dividend reinvestment plan must be reported in
income.
Regulated investment companies (mutual funds) and real estate investment trusts (REITs) pay capital
gain distributions. These capital gain distributions are reported in Box 2a of Form 1099-DIV. If 1099-
DIV has only capital gain distributions in Box 2a and 2b the amount can be reported on line 13a and 13b
of the 1040 and check the box on the line.
When Schedule D is required in the return the capital gain distributions will net with the other capital
gains on the Schedule D.
Nontaxable Distributions
A nontaxable distribution is a return of capital or a tax-free distribution of shares of stock or stock
rights. It is a return of the investment in the stock of the company. Distributions by a corporation of its
own stock are commonly known as stock dividends. Stock rights or options are distributions by a
corporation of rights to acquire the corporation stock. Generally these nontaxable distributions are not
reported on the tax return.
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81. Which of the following is not taxable interest received?

A. Interest on a bank account
B. Interest on loans to others
C. Capital gain distributions
D. Interest from certificate of deposits
82. Generally, the _______ is used when the interest is reported in the year it is actually or
constructively received.
A. Accrual method
B. Cash method
C. Inventory method
D. Weighing method
83. For taxpayers using the accrual method of accounting the interest is taxable when it is accrued,
whether or not the taxpayer has received it.
A. True
B. False
84. Taxable interest from U.S. savings bonds are reported to the taxpayer using this form:
A. Form 1099-DIV, box 4a
B. Form Schedule B, box 2b
C. Form 1098, box 3
D. Form 1099-INT box 3
85. Which of the following is an acceptable maturity period for Treasury Bills?
A. 4-week,
B. 15-week,
C. 30-week
86. Dividends that really are interest come from the following sources, except
A. Cooperative banks
B. Credit Unions
C. Domestic building and loan associations
D. Mutual fund accounts
87. The difference between the discounted price the taxpayer pays for the bills and the face value
received at maturity is interest income.
A. True
B. False
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88. When a long-term debt instrument in issued at a price that is lower than its stated redemption value,
the difference is called which of the following?
A. Capital loss
B. Discounted debt
C. Original issue discount
D. Ordinary dividend
89. The taxpayer is allowed to use Form 1040EZ if interest income is less than _______.
A. $400
B. $1500
C. $1200
90. If the taxpayer is filing form 1040 or 1040A, Schedule 1 or Schedule B, which of the following must
be present to require Schedule B to be completed.
A. Taxable interest income exceeds $1300.
B. Taxpayer is not claiming the interest exclusion under the Education Saving Bond Program.
C. Seller-financed mortgage interest and the buyer used the property as a home.
D. Taxpayer received a 1098-INT for tax exempt interest.
91. Interest paid on money borrowed to invest is a separate transaction from the money earned on the
investment. The interest paid on the money borrowed is deductible if the taxpayer itemizes. Report
the investment interest on which form?
A. Form 4952
B. Form 4562
C. Form 8801
D. Form 8814
92. The taxpayer must file form 1040 and use Schedule B if they had interest from or authority over a
foreign bank account.
A. True
B. False
93. When the registered owner receives a 1099-INT, but the interest actually belongs to someone else it
is considered:
A. A mistake
B. Nominee Interest
C. Mortgage Interest
94. The taxpayer claiming the nominee distribution:

A. Does not have to notify the actual owner of the interest
B. Must send the actual owner of the interest a certified letter
C. Must issue a 1099-INT to the actual owner of the interest
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95. Interest received on _______ issued after 1989 to a taxpayer over the age of 24 may exclude the
interest income from that bond if during the year the taxpayer paid qualified higher education
expenses to an eligible educational institution.
A. Series II Bonds
B. Series CC Bonds
C. Series EE Bonds
96. _______ are distributions of money, stock or other property paid to the taxpayer by a corporation.
A. Dividends
B. Stocks
C. Bonds
D. Interest
97. Which of the following are not ways dividends may be received?
A. Partnership
B. Estate
C. Corporation
D. Fringe Benefits
98. The most common type of dividends paid out of earnings and profits of a corporation are called:
A. Qualified Dividends
B. Ordinary Dividends
C. Standard Dividends
D. Bank Dividends
99. Ordinary dividends are reported on form:

A. 1099-MISC
B. 1099-INT
C. 1099-DIV
D. 1098
100. Which statement below is incorrect about how to report dividends?

A. Ordinary dividend income that exceeds $1,500 must be reported on Schedule 1 when filing
Form 1040A and on Schedule B when filing Form 1040.
B. The amount from Schedule B is carried to the 1040, line 9a.
C. Dividends cannot be entered on Form 1040 without a Schedule B, being in the return.
D. Qualified dividends are carried to page 2 of Schedule D, line 23
101. Tax on ______________is taxed at the same rate as long-term capital gains received in 2008.
A. Qualified Dividends
B. Ordinary Dividends
C. Adjusted Gross Income
D. Schedule D
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102. Ordinary dividends reinvested into stock through a dividend reinvestment plan must be reported
as:
A. Adjustment to income
B. Income
C. Credit on tax due
D. Deduction
103. Regulated investment companies (mutual funds) and real estate investment trusts (REITs) pay
capital gain distributions.
A. True
B. False
104. Which of the following is not an example of nontaxable distribution?

A. Return of capital
B. Stock rights
C. Options
D. Gift certificates
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Chapter 5 – Cancellation of Debt, Refunds, Alimony and
Business Income
Cancellation of Debt
If a debt owed is cancelled or forgiven, other than a bequest or gift, the
amount cancelled is income. A debt includes any indebtedness for which the
taxpayer is liable or which attaches to property for which the taxpayer is liable. If the debt
forgiven is $600 or more a 1099-C is issued and the amount must be reported on Line 21 of
Form 1040.
Excerpt from 2008 Pub 17
Exceptions to the inclusion of cancelled debt as

income.
• Student Loans: Certain student loans
provide a provision that all or part of the
debt incurred to attend the qualified
institution will be forgiven if the taxpayer
works for a certain period of time in
certain professions or for a broad class of
employers (Refer to Pub 17, Part 4,
Chapter 12)
• Education Loan Repayment Assistance:
Education loan repayments made to the
taxpayer by the National Health Services
Corps Loan Repayment program or state
education loan repayment program
eligible for funds under the Public Health
Services Act are not taxable if the
taxpayer agrees to provide primary health
services in health professional areas.
• Deductible Debt: The taxpayer does not
have income from cancellation of debt if
the payment of the debt would have been
deductible. The exception applies only if
you use the cash method of accounting.
Refer to Pub 334.
• Price Reduced After Purchase:
Generally, if the seller reduces the
amount of the debt the taxpayer owes for
property purchased then the income from
the reduction is not recognized. This is
treated as a purchase price adjustment and reduces the basis.
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• Excluded Debt: Do not include cancelled debt in income in the following instances:
o The debt is cancelled in bankruptcy case under Title 11 if the U.S. Code.
o The debt is cancelled when insolvent, up to the amount the taxpayer was
insolvent.
o The debt is qualified farm debt and is cancelled by a qualified person. Refer to
Pub 225.
o The debt is qualified real property business debt. Refer to Pub 334
o The cancellation is intended as a gift.
o The debt is qualified principal residence debt. Refer to Pub 525
Federal income tax refund is not included in income because it is never allowed as a deduction from
income.
State Tax Refund
If there is a state or local income tax refund (or credit or offset) in 2008, the taxpayer generally must
include it in income if the taxpayer deducted the tax in an earlier year. The payer should send Form
1099-G, Certain Government Payments, to the taxpayer by January 31, 2008. The IRS also will receive
a copy of the Form 1099-G. Use the worksheet in the Form 1040 instructions for line 10 to figure the
amount (if any) to include in income.
For 2008 the taxpayer can choose to deduct:
• State and local income taxes, or
• State and local general sales taxes
The refund that the taxpayer must include in income is limited to the excess of the tax chosen to deduct
over the tax not chosen to deduct.
Example: For 2008 the taxpayer can choose an $11,000 state income tax deduction or a $10,000 state
general sales tax deduction. The taxpayer chooses to deduct the state income tax. The taxpayer received
a $2,500 state income tax refund for 2007. The taxpayer must include $1,000 of the refund in income
since he could have deducted $10,000 in state sales tax.
Alimony Received
Alimony, maintenance, separate maintenance payments, support and spousal support are
interchangeable terms for federal tax purposes. Payments that qualify are deductible by the payer spouse
and taxable to the payee spouse. Alimony received is reported on Line 11 of Form 1040.
To qualify as alimony payments must be:
1. Cash (including checks and money orders)
2. Required by decree
3. Spouse cannot be of the same household
4. Payments may not be treated as child support
5. Payer' s liability must cease at death
6. Parties may not file a joint return
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Payments that do not qualify:
1. Child support
2. Non-cash property settlements
3. Payments that are the spouse's part of community property
4. Payments for use of property
5. Payments to keep up the payer’s property.
Refer to Pub 504 for more information.
Independent Contractor vs. Employee
The classification of workers is important
for both the worker and the employer. If an
employee is classified as an independent
contractor then they are responsible for
paying self-employment tax on their
earnings. If the worker is classified as an
employee the employer becomes responsible
for:
• Employment taxes being
withheld, such as FICA, federal
and state income taxes
• Employers share of FICA
• State and federal unemployment
taxes
• Retirement plan eligibility
This definition is from IRS Publication 334.
Common Law Rules are a set of factors arising out of Revenue Ruling 87-41 used to determine if a
worker is an employee or an independent contractor:
1. Behavior control factor – An employer retains the right to control how the work is done. Usually
an independent contractor retains control over the work
2. Financial control factor- An employer has the right to control how the business aspects of an
employee’s business are conducted. The employer would realize the profit or loss and make a
significant investment in the business. An independent contractor controls his or her own
business activities.
3. Relationship factor - An employer would have a continuing relationship with the employee, who
would be an integral part of the business and as such provide benefits for the employee. An
independent contractor would have a written agreement determining method of payment,
handling of expenses and how and when the work is to be done, designating the worker as an
independent contractor.
4. There are many other less important factors that are also weighed in determining the status, such
as:
• The right to discharge a worker or the worker’s right to quit
• Part or full-time work requirement
• Work required at the employers location
• Setting hours and sequence of work
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Business Income – Schedule C
This excerpt is from IRS Publications 334.
Any income connected to a business is

business income. A connection exists if it is
clear that the payment of income would not
have been made if the business did not
exist. Income from work done in addition
to a full time job can also be considered
business income; the work does not have to
be on a regular full-time basis.
Business income from the sale of products or services is reported on Schedule C or C-EZ. Schedule C
is designed to report income by a sole proprietor (single owner of a business). All Schedule C income
must be classified by their activity. An activity code based on the North American Industry
Classification System must be entered in block B on Schedule C.
All moneys received from business must be included in income unless excluded by law. Income from
miscellaneous sources are reported on 1099-MISC, whether the income is reported on a 1099 or not it
must be included in income. Accounting of gross receipts should be kept according to generally
accepted accounting practices on a daily basis. Refer to Pub 583 for record keeping requirements.
Other Kinds of Income

1. Bartering is an exchange of property for services. Bartering income must be included in gross
receipts determined by the fair market value of the goods or services. Both people or companies
involved in the exchange must report the income.(Barter income is reported on 1099-B)
2. Personal property renting (equipment, vehicle rental, formal wear) income must be included in gross
receipts.
3. Income created from debt cancellation is business income if the debt is incurred in the business.
4. Other items of income reported on Schedule C:
• Restricted property
• Promissory notes
• Lost income payments
• Patent infringement
• Breach of contract
• Antitrust injury
• Kickbacks
• Recovery of items previously deducted
• Recapture of depreciation:
• Listed property which falls below 50% business use (refer to Pub 926)
• Section 179 expense taken on property where the business percentage falls below 50%
before the end of the recovery period. (refer to Pub 926)
• Sale or exchange of depreciable property at a gain (refer to Pub 544)
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IRS Publication 334
Items that are Not Income

1. Loans
2. Sales tax
3. Appreciation
4. Leasehold improvements
5. Exchange of like-kind property
6. Consignments
7. Construction allowances
8. Short-term lease
9. Retail space
10. Qualified long-term real property
IRS Publication 334
Cost of Goods Sold

If the business makes or buys goods to sell,
the cost of goods sold can be deducted from
gross receipts on Schedule C. To determine
the cost of goods sold the inventory must be
valued at the beginning and the end of each
tax year.
Inventory at Beginning of the Year

The cost of merchandise on hand at the beginning of the year that is available to be sold to customers.
Purchases less cost of items withdrawn for personal use – a merchant uses the cost of all
merchandise, bought for sale; a manufacturer or producer includes the cost of all the raw materials or
parts purchased for manufacture into the finished product.
• Trade discounts - The difference between the stated amount and the actual amount. The cost
of purchases is the amount actually paid
• Cash discounts - Amount discounted from invoices for prompt payment, must be credited to
either a separate account or subtracted from purchases
• Purchase returns and allowances - Must be deducted from purchases
• Merchandise withdrawn for personal use must be excluded from cost
Cost of labor – Labor costs are usually an element of the cost of goods sold only in manufacturing and
mining.
Materials and Supplies – some supplies such as hardware and chemicals used in manufacturing are
charged to cost of goods sold. These can also be deducted as business expenses.
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Cost of Goods Sold = Cost of inventory on hand at the beginning of the year plus Cost of inventory
acquired during the year plus Shipping costs to receive inventory (not the finished product) plus
Direct cost of labor that produces inventory plus Depreciation on machinery that produces the
inventory minus Inventory removed for personal use minus Cost of inventory on hand at the end of
the year.
Gross Receipts minus Cost of Goods Sold plus Other Income = Gross Income minus Business
Expenses = Tentative Profit minus Business Use of Home = Net Profit or Loss
Business Expenses – an ordinary expense is one that is common and accepted in the field of business. A
necessary expense is one that is helpful and appropriate.
Determining what is ordinary expense common and accepted in the particular field of business of the
taxpayer, use the Schedule C and the Schedule C instructions as a guide. The most common expenses
are preprinted on the form; additional expenses are listed on page 2 of Schedule C. Refer to Pub 535 for
more information on business expenses.
Record keeping is an essential part of business. The tax practitioner should instruct the taxpayer to
bring adequate records to the tax interview. To meet adequate recordkeeping requirements the taxpayer
must maintain an account book, diary, log, statement of expense, trip sheet and/or similar record or other
documentary evidence that together with the receipt is sufficient to establish each element of an
expenditure or use. The information already shown on the receipt does not have to be repeated in the
record, however the records should back up the receipts.
An adequate record contains enough information on each element of every business or investment use. If
an asset is being depreciated notes must be kept in regards to the basis. If Section 179 is claimed in the
first year, all the information should not only be noted on the correct form in the tax returns, but in the
record keeping, so the basis can easily be determined.
Meals and Entertainment are deductible only if they are directly related or associated with the active
trade or business incurred while the taxpayer or his employee is present at a meal. A facility used for the
meal cannot be deducted. Meals and entertainment expenses are taken at 50%. Refer to Pub 463 for
more information.
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Travel for business expenses while away from the tax home are deductible. The tax home is the main
place business is conducted regardless of where the
personal residence is located. Refer to Pub 463 for more
information.
Depreciation – if property acquired in a business is

expected to last more than one year, generally the entire
cost cannot be deducted in the year acquired. The
process of spreading the cost over more than one year is
depreciation. (Refer to depreciation in Chapter 7 in this
text or Pub. 946).
What property can be depreciated?

• Owned property
• Property used in business or held to produce
income
• Property must have a useful life that is
substantially more than one year
• Property must have a determinable useful life,
which means it must be something that wears
out, decays, becomes obsolete or loses value
• The property cannot be property that is
purchased and sold in the same year
This excerpt is from Form 4562 instructions.

Refer to the complete 4562 instructions for more
information on depreciation and expensing items
under Section 179.
In 2008 a taxpayer can expense up to $250,000

under Section 179 on qualifying property up to
$800,000. In 2009 a taxpayer can expense up to
$133,000 under Section 179 on qualifying
property up to $530,000.
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Listed property is any of the following:
• Most passenger automobiles
• Most other properties used for transportation
• Any property of a type generally used for entertainment, recreation or amusement
• Certain computer and related peripheral equipment
• Any cellular telephone
Recordkeeping on a vehicle used for business must be kept in an adequate log, noting what is of
business use. A mileage log is essential, not only if the standard mileage rate is to be used, but to
determine the correct percentage of business use. Records should always be in written form, with dates
and business purpose noted. If the business records are being kept for a route that is the same every day,
the adequate mileage of the route and a log of any deviations will suffice.
Home computers and other listed property should be detailed in the same way. With a home computer
total number of hours on the computer and an adequate log being kept next to the computer for business
use is adequate.
Self-Employed Health Insurance

Health insurance paid on behalf of employees is a business expense. Medical and dental insurance for
the taxpayer and his/her family is an adjustment to income reported on Form 1040, line 29. Refer to
Form 1040 instructions for the worksheet or Pub 535.
Pension Plans
A small business can set up retirement plans for the taxpayer and employees
• SEP (Simplified Employee Pension) plans
• SIMPLE (Savings Incentive Match Plan for Employees) plans
• Qualified plans (including Keogh or H.R. 10)
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Contributions to a plan made for an employee can be deducted on Schedule C, if the contribution is for
the taxpayer it is deducted on line 28 of Form 1040. (Refer to Pub. 560).
Before computing the business use of home complete Schedule C through the tentative profit by
subtracting the business expenses from the gross income.
Business Use of Home

To qualify to claim expenses for the business portion of a home specific
requirement must be met:
1. Use of the business part of the home must be exclusive (a room or
identifiable place), regular (continuing basis), for the specific business and
2. Must be one of the following:
• Principal place of business (can have more than one place of doing
business, including the home)
• A place to meet and deal with patients, clients or customers in the
normal course of doing business
• A separate structure used in the course of business
If the gross income from the business use of the home equals or exceeds the total business expenses, the
business expenses related to the office in the
home are deductible. If the gross income from
business use of the home is less than the total
business expenses the deduction for the
business use of the home is limited.
The deduction of otherwise nondeductible

items such as insurance, utilities, and
depreciation (with depreciation taken last)
allocable to the business is limited to the gross
income from the business use of the home
minus the sum of the following:
• The business part of expenses that
could be deducted even if the home
was not used for business (such as
itemized deductions)
• The business activities that relate to
the business activity on the home
but not to the home itself (such as
the telephone costs)
The net profit is computed by subtracting any

office in home expense from the tentative
profit. Refer to Form 8829 instructions or Pub
587.
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Schedule SE
Social security coverage is based on the payments of SE tax the taxpayer contributes under the social
security system. The taxpayer qualifies for social security benefits if they have the required number of
credits (also called quarters of coverage). The taxpayer with income subject to SE tax received one
credit for every $1,090 of income subject to SE in 2009.
Reasons to use the Optional Methods of computing SE tax if there is a loss or a small net
profit where filing Schedule SE is not required
• The taxpayer receives credit for social security benefit coverage
• The optional method may increase the earned income component for computing
child or dependent care credit
• The optional method may increase the earned income component for computing an earned
income credit
• The optional method may increase the earned income component for computing an additional
child tax credit
The taxpayer can deduct one-half of the SE tax as an adjustment to income on line 27 of Form
1040.
Refer to Pub 334 for a detailed discussion

of the methods for figuring net earnings
from self-employment.
Self-employment tax and the profit from

Schedule C are not subject to withholding.
To avoid an underpayment of tax penalty,
compute the estimated tax for the next year
by starting with the current year income,
deductions and credits, and use the ES
worksheet. Make adjustments for changing situations. Standard due dates for estimated tax payments are
Apr. 15, June 15, Sept 15 and Jan 15 of the next year.
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105. A State Tax Refund from the prior year may be taxable in the current year if
the taxpayer
A. Paid state tax in the current tax year
B. Itemized their deductions in the prior year
C. Took the Standard Deduction in the prior year
D. Contributed to an IRA account
106. For 2008, the refund that the taxpayer must include in income is limited to the excess of
the sales tax or the state income chosen to deduct over the sales tax or the state income tax
not chosen to deduct.
A. True
B. False
107. Form 1040 line 10 is used to report:

A. Property tax
B. Refunds from state or local taxing authorities
C. Business tax
D. Federal income tax refunds
108. Which of the following is not a qualification for alimony included in income by one
spouse and deducted by the other?
A. Payment must be in cash (check or money order)
B. Required by decree
C. Parties must include child support
D. Payer’s liability must cease at death
109. Which of the following payments do not qualify as alimony?

A. Child support
B. Non-cash property settlements
C. Payment that are the spouse’s part of community property
D. All of the above
110. Independent contractors are not responsible for paying self-employment tax:
A. True
B. False
111. When a worker is classified to be independent contractors, which of the following

statements apply?
A. The employer has the right to control how the business aspects of the contractor’s
business are conducted.
B. The employer must have a continuing relationship with the contractor
C. The employer retains the right to control how the work is done
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112. Which one of the following describes the three main factors for determining if a worker
is an employee or a contractor?
A. Behavior Control, Financial Control, Relationship
B. Performance Control, Economic Control, Association
C. Production Control, Industry Control, Companionship
113. Barter income is determined by the fair market value of goods and services.
A. True
B. False
114. Any income connected to a business is considered to be:

A. Taxable income
B. An adjustment to income
C. Business income
D. Personal Income
115. Use Schedule C or C-EZ when reporting income or loss from a business the taxpayer
operates as a:
A. Partnership
B. Sole proprietor
C. Sub Corporation
D. Corporation
116. What is the responsibility of a sole proprietor who receives money that is not reported on
a 1099-MISC?
A. They do not have to report the money
B. They can report it if they choose
C. Report 50 percent of the money
D. They must include the money in income, unless excluded by law
117. Accounting of gross receipts;

A. Is optional
B. Should be kept according to generally accepted accounting practices on a daily basis
C. Should be kept according to generally accepted accounting practices on a monthly
basis
118. Which of the following is true regarding record keeping for the self-employed taxpayer?
A. The information that is shown on a receipt does not have to be repeated in the record.
B. Adequate records contain enough information on every element of every business.
C. Notes on depreciable assets should be kept in respect to basis.
D. All of the above
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119. Other kinds of income reported on Schedule C or C-EZ include.
A. Restricted property
B. Promissory notes
C. Patent infringement
D. All of the above
120. Exchange of property for services is called?

A. Switching
B. Borrowing
C. Trading
D. Bartering
121. Barter income must be included in which of the following:

A. Gross receipts
B. Expenses
C. Cost of goods sold
D. Inventory
122. Which of the following personal property rental income must be included in gross
receipts?
A. Equipment
B. Vehicle rental
C. Formal wear
D. All of the above
123. Which of the following are included in income on Schedule C?

A. Debt cancellation from debt incurred by the business
B. Exchange of like-kind property
C. Retail Space
D. Sales Tax
124. Cost of goods sold are:

A. Added to the gross receipts
B. Deducted from the gross receipts
C. Neither A or B
125. To determine the cost of goods sold the inventory must be valued;
A. At the beginning of the previous year
B. June 1st of the current tax year
C. At the beginning and the end of the tax year
D. December 31st of the current tax year
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126. Cost of goods sold start with which of the following?
A. Inventory at beginning of year
B. Materials and supplies
C. Cost of labor
D. Inventory at the end of the year
127. Computer C, line 36; merchandise withdrawn for personal use must be;
A. Ignored
B. Excluded from cost
C. Listed on page 1 of Schedule C
D. Included in cost
128. Gross receipts minus cost of goods sold plus other income equals which of the following:
A. Net income
B. Net profit or loss
C. Gross income
129. Gross income minus business expenses equals which of the following:
A. Tentative profit
B. Cost of goods sold
C. Gross receipts
D. All of the above
130. Tentative profit minus business use of the home equals which of the following:
A. Gross income
B. Business Expenses
C. Gross receipts
D. Net profit or loss
131. Which of the following is considered an ordinary expense?

A. An expense that is common and appropriate in that field of business
B. An expense that is common and accepted in that field of business
C. An expense that is helpful and common in that field of business
D. A accepted expense in that field of business
132. If property acquired in a business is expected to last more than one year, generally the
entire cost cannot be deducted in the year acquired.
A. True
B. False
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133. Which of the following describes the process of spreading the cost over more than one
year of an acquired property?
A. Appreciation
B. Depreciation
C. Depletion
134. Which of the following property cannot be depreciated?

A. Owned property
B. Property that has a useful life that is substantially more than one year
C. Property that is purchased and sold in the same year
D. Property used in business or held to produce income
135. A Section 179 deduction is the amount determined by code that can be expensed in
_____________.
A. The year of sale
B. The year of purchase
C. The third year that the property is owned
136. A Section 179 expense is reported on Form 4562, Part III?

A. True
B. False
137. What is the maximum amount of Section 179 expense allowed in 2008?
A. $30,000
B. $250,000
C. $125,000
D. $100,000
138. Which of the following is considered to be listed property?

A. Most passenger automobiles
B. Any property of a type generally used for entertainment, recreation or amusement
C. Any cellular telephone
D. All the above
139. Which of the following would be an adequate recordkeeping method to track the basis of
a business asset?
A. Business ledger and the receipt
B. Mileage log
C. Receipt with notes on the back
D. Information verbally given to a tax preparer.
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140. Adequate record keeping must always be written and contains enough information on
each element of every business or investment use.
A. True
B. False
141. Which of the following statements are true regarding travel and meals and entertainment?
A. Meals and Entertainment are deductible only if they are directly related or associated
with the active trade or business incurred while the taxpayer or his employee is
present at a meal.
B. A facility used for the meal cannot be deducted
C. Travel for business expenses while away from the tax home are deductible.
D. All of the above
142. Use ________ to report depreciation.

A. Form 1040
B. Form 4562
C. Form 4797
D. Form 2210
143. If self-employed, medical and dental insurance for the taxpayer and their family is treated
as which of the following?
A. As a deduction on Schedule A
B. As a expense on Schedule C
C. As an adjustment to income reported on Form 1040
144. A small business retirement plan for the taxpayer and their employees may include the
following, except;
A. SEP (Simplified Employee Pension) plans
B. A traditional IRA
C. SIMPLE (Savings Incentive Match Plan for Employees) plan
D. Qualified plans (including Keogh or H.R. 10)
145. In order to qualify to claim expenses for the business portion of a home, which of the
following requirements must be met?
A. Business part of the home must be exclusive (a room or identifiable place)
B. Business part of the home must be used on a regular (continuing basis)
C. Business part of the home must be used for a specific business
D. All of the above
146. If the gross income from the business use of the home equals exceeds the total business
expenses, the business expenses related to the office in the home are deductible.
A. True
B. False
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147. The net profit on Schedule C is computed by subtracting any office in home expense
from the ___________.
A. Gross receipts
B. Gross income
C. Other income
148. Self-employment tax (SE tax) is primarily for which of the following?
A. Employees
B. Sole proprietors
C. Individuals who are not employed
D. Individuals who do not want their employers to withhold social security and Medicare
taxes from their pay.
149. By not reporting all of the self-employment income from their business the taxpayer may
cause the social security benefits to be lower upon retirement.
A. True
B. False
150. A taxpayer qualifies for social security benefits if they have the required number of
quarters of coverage,
A. True
B. False
151. Which of the following methods can be used to compute net earnings from self-
employment to compute SE tax?
A. The regular method
B. The nonfarm optional method
C. The farm optional method
D. All of the above
152. The taxpayer must pay _____________ for the Medicare portion of S/E taxes on all net
earnings.
A. 20%
B. 15.3%
C. 2.9%
D. 12.40%
153. How much of the SE tax is deducted as an adjustment to income on Form 1040?
A. One-third
B. One-half
C. 10 percent
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154. In 2008, only the first $102,000 of combined wages, tips and net earnings are subject the
Social Security Tax portion of the self-employment tax.
A. True
B. False.
155. Which of the following statements are correct?

A. Schedule C profit is subject to withholding.
B. Self-employment tax does not have to be paid until the return is filed.
C. The profit from Schedule C and self-employment tax should be taken into
consideration when determining whether estimated tax payments are required.
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Chapter 6 - Capital Assets
Most properties owned and used for personal purposes, pleasure or investment
are capital assets, such as a personal residence, furniture, car, stocks and
bonds. A capital asset is any property held by the taxpayer except:
• Stock in trade or other property included in inventory or held
mainly for sale to customers
• Accounts or notes receivable for services performed in the ordinary
course of trade or business
• Depreciable property used in trade or business
• Copyrights, literary, musical or artistic compositions, letters or memoranda or similar
property
(a) Created by the taxpayer’s personal efforts
(b) Prepared or produced by the taxpayer
(c) Received from someone who created them or for whom they were created, as
mentioned in (a) or (b) in a way that entitled the taxpayer to the basis of the
previous owner.
• U.S. Government record including the Congressional Record
• Certain commodities derivative financial instruments held by a dealer (Section
1221(a)(6))
• Certain hedging transactions entered into in the normal course of trade or business.
(Section 1221(a)(7))
• Supplies regularly used in the trade or business
Basis of Property
The basis of property bought is usually its cost. The cost is the amount paid in cash, debt
obligations, other property or services. The cost also includes amounts paid for the following
items:
• Sales tax
• Freight
• Installation and heating
• Excise taxes
• Legal and accounting fees (when they must be capitalized)
• Revenue stamps
• Recording fees
• Real estate taxes (if assumed for the seller)
Real property, also called real estate, is land and generally anything built on, growing on, or
attached to land. Land is not depreciable if the cost is a lump sum; allocate the cost according to
the fair market value of the land and buildings at the time of purchase.
Fair market value (FMV) is the price at which the property would change hands between a
willing buyer and a willing seller, neither having to buy or sell, and both having reasonable
knowledge of all the necessary facts.
Adjusted basis – before figuring gain or loss on a sale, exchange, or other

disposition of property or figuring allowable depreciation, depletion or
amortization, certain increases or decreases to the basis may be needed. The
79
result of the increases or decreases is the adjusted basis.
This chart is from Publication

17, Part 3, Gains and Losses.
Basis other than cost is

computed by using the fair
market value or the adjusted
basis. If property is received for
services the property is included
in income at the fair market
value. This FMV becomes the
basis. If an asset is purchased at
bargain prices (less than the
FMV) include the difference
between the discounted cost and
the FMV in income and the
FMV becomes the basis.
A taxable exchange is one in

which the gain is taxable or the
loss is deductible. A taxable
gain and deductible loss is also known as a recognized gain or loss. The basis of property
received in exchange for other property in a taxable exchange is usually the FMV at the time of
the exchange.
The most common taxable exchange is an involuntary conversion. If the taxpayer

receives property due to an involuntary conversion, such as a casualty theft or
condemnation, the basis of the replacement property is computed by using the
basis of the converted property. If the property received is similar or related in
service or use to the converted property, the new basis is the same as the converted
property on the date of the conversion, with the following adjustments:
• Decreasing the basis by any loss recognized on the conversion and any money
received that was not spent on similar property
• Increase the basis by any gain recognized on the conversion and any cost of acquiring
the replacement property
A nontaxable exchange is an exchange in which the taxpayer is not taxed on the gain and not
able to deduct the loss. In these transactions the basis is generally the same as the property
transferred.
A like-kind exchange is an exchange of property for the same kind of property and is the most
common type of nontaxable exchange. In a like-kind exchange the property traded and the
property received must both be qualifying property and like-kind property. Qualifying property
in an exchange must either be held for investment or for productive use in a trade or business.
Like-kind property is property of the same nature and character, even if it differs in quality or
grade. The exchange of real property for real property or personal property for personal property
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is an exchange of like property. A like kind exchange is reported on Form 8824 refer to these
instructions for more information.
The basis of property received as a gift is the FMV less the donor’s adjusted basis. To determine
this amount the taxpayer must determine whether there is a gain or a loss when disposing of the
property. The basis for figuring the gain is the donor’s adjusted basis plus or minus any required
adjustments to basis while the property was held. The basis for figuring a loss is the FMV when
the gift was received plus or minus any required adjustments. (Refer to Pub 551.)
Stocks, Bonds and Mutual Funds
The basis of stocks or bonds generally is the purchase price plus any costs of
purchase, such as commissions and recording or transfer fees. If the taxpayer
receives stocks or bonds other than by purchase, the basis is determined by the fair
market value or the previous owner’s adjusted basis. The basis is also adjusted by
certain events that occur after purchase such as stock splits, where the number of the old and new
shares must divide the basis of the old stock if the new stock received is identical to the old
stock. Nontaxable distributions also reduce the basis.
There are other methods of determining basis of stocks having to do with how the stocks were
acquired. (Refer to Pub. 550.)
The basis in mutual funds is determined in the same manner as stocks and bonds. If the taxpayer
sells mutual fund shares at various times and prices the taxpayer can choose to use an average
basis. (Refer to Pub 564.)
Sale of Property
Form 1099-B or equivalent statement is issued when stocks, bonds or certain commodities are
sold through a broker. A sale is generally a transfer of property for money or a mortgage, note or
other promise to pay money. A trade is a transfer of property for other property or services and
may be taxed the same way as a sale. Redemption of stock is treated as a sale or trade and is
subject to the capital gain or loss provisions unless the redemption is a dividend or other
distribution on stock. The gross sales price of the item is shown in Box 2 of 1099-B.
Redemption of retirement of bonds is considered a sale. A worthless security that became

worthless during the year is treated as though it was sold on the last day of the year.
If real estate is sold the transaction is reported on 1099-S. Gross proceeds from the sale or
exchange is shown in Box 2. Reportable real estate is defined as any present or future ownership
interest in any of the following:
• Improved or unimproved land

• Inherently permanent structures, including residential, commercial or industrial
buildings
• A condominium unit and its accessory fixtures and common elements, including land
• Stock in cooperative housing corporation
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Sale expenses are added to the basis. Sale expenses include commissions, state and local transfer
tax, broker’s fees and option premiums. For real estate sales expense of sale includes attorney
fees, title and escrow fees, broker’s fees and mortgage lender fees.
Gain and Loss
To compute a gain or loss on the sale of property compare the amount realized
with the adjusted basis of the property. If the amount realized is more than the
adjusted basis of the property transferred, the difference is a gain. If the adjusted
basis is more than the amount realized, the difference is a loss. The amount realized is
everything received for the property.
The sales price in a sale or trade of property is everything received for that property. This
includes money, plus the fair market value of property or services received for that property.
Capital Gain Tax Rates
Schedule D
Refer to the instructions for Schedule D on the proper reporting on Page 2 of Schedule D of
capital gains in each tax bracket. There is a limitation on the amount of capital loss allowed in
the current year. The allowable capital loss in the current year is the lesser of:
1. $3,000 ($1,500 if married filing a separate return)

2. The total net loss shown on Schedule D
If there is a total net loss more of than the yearly limit on capital loss deductions the unused part
is a short or long-term carryover to the next year. It can be carried over until used up. The
allowable deduction in the current year must be taken into account when computing the
carryover, whether or not the deduction was claimed. The carryover loss remains either long
term or short term. A long-term carryover loss that is carried to the next year will reduce that
year’s long-term gain before it is used against that year’s short-term gains. (Refer to the Capital
Loss Carryover Worksheet in Pub 550).
82
Short Term Gain or Loss is a capital gain or loss on the sale or trade of investment property
held 1 year or less. Report on Schedule D, Part I. Short-term carryover losses are used first when
figuring the capital loss carryover even if the long-term losses were created after the short-term
losses.
To figure the net short-term capital gain or loss combine short-term losses from partnerships, S-
corporations and fiduciaries and any short-term carryover losses with other short-term gains or
losses.
Long-term gains and losses are defined as a capital gain of loss on the sale of investment
property held more than one year. Report long-term capital gains and losses in Part II of
Schedule D. Also report the following items in Part II of Schedule D:
1. Undistributed long-term capital gains from a regulated investment company (mutual

funds) or real estate investment trust (REIT)
2. The taxpayer share of long-term capital gains or losses from partnerships, S-corporations
and fiduciaries.
3. All capital gain distributions from mutual funds and REIT’s not reported directly on
Form 1040.
4. Long-term capital loss carryovers.
Collectibles gain or loss is a capital gain or loss from the sale or trade of a work of art, rug,
antique, metal (such as gold, silver or platinum) gem, stamp, coin, or alcoholic beverage held
more than one year.
If the taxpayer realizes a gain on qualified small business stock held more than 5 years under
the provisions of Section 1202, half the gain can be excluded from income. The taxable portion
of the gain is taxed at 28%. (Refer to Pub 550.)
Unrecaptured Section 1250 gain is any part of a capital gain from selling of Section 1250
property (real property) due to depreciation (but not more than the net section 1231 gain)
reduced by any net loss from the 28% group. To compute the Unrecaptured Section 1250 gain
refer to the work sheet in Schedule D instructions, Form 4797 instructions or Pub 544).
83
Sale of Personal Residence
For sales of a personal residence after May 6, 1997, a homeowner may exclude from
income up to $250,000 of gain and a married couple may exclude up to $500,000 of
gain realized on the sale. The Section 121 exclusion requires individuals to meet the
following conditions:
• Ownership and use test: The individual must have owned and used the
home as a principal residence for at least two out of the five years prior to the sale
(the two years do not have to be consecutive). The taxpayer must own the home
directly not through an entity
• Frequency limitation: The exclusion applies to only one sale every two years
• The Section 121 exclusion requires married couple to meet the following conditions:
• Joint return: The married couples must file a joint return
• Ownership: Either or both spouse(s) must have owned and used the home as a
principal residence for at least two out of the five years prior to the sale (the two years
do not have to be consecutive). The taxpayer must own the home directly not through
an entity
• Use: Both spouses must have used the residence as their principal residence for at
least two out of five years prior to the sale
• Neither spouse may have sold a home more than once every two years
Reduced exclusion: taxpayers who do not meet the two-year ownership and use test of Section
121 may qualify for a reduced exclusion if the taxpayer sold a home due to:
• Job relocation - The new job location must also be at least 50 miles farther from the
residence sold than was the former place of employment
• Health - A sale is due to health if the primary reason for the sale is to obtain, provide
or facilitate the diagnosis, cure, mitigation or treatment of disease, illness or injury of
a qualified individual
• Unforeseen circumstances such as the following:
Natural and man-made disasters or acts of war or terrorism resulting in a casualty
to the residence.
Death, loss of job, change in job status, divorce or legal separation, multiple births
from the same pregnancy. Involuntary conversion of residence
An event the IRS determines as an unforeseen circumstance.
A prorated exclusion of gain based on the period of time the homeowner meets the ownership
and use requirements, and the period of time between the most recent sale of home and current
sale. (Refer to Pub 544 for the “Sale of Home” worksheet.)
Dispositions other than Sales

The following excerpts from Pub 17 regarding foreclosure and
repossession of personal residence. Refer to Pub 523 for more
information regarding foreclosure and abandonment of a
personal residence.
84
Sale of Business Property (Form 4797) and Installment Sales
(Form 6252)
Installment sales are sales of real or personal property (other than inventory) for
which the taxpayer will receive payments after the year of sale. Installment sales
that result in a loss are not qualified for installment sale treatment even if a
payment is made after the tax year. Each payment in an installment sale consists of three parts:
1. Interest
2. Gain on the sale
3. Recovery of basis
Interest must be charged at a rate at least equal to the IRS minimum. The amount of interest is
subtracted from the total of payments made and the remainder is split between gain on sale and
recovery of basis.
In the year of sale the gross profit percentage is calculated for the installment sale to determine
how much of each payment is profit. The gross profit percentage is calculated by dividing the
amount of gross profit by the contract price. The contract price includes the total of all principal
payments to be made by the buyer over the term of the installment sale. The gross profit
percentage is calculated only in the year of sale and used for each subsequent year. The sale
retains it’s characteristics of ordinary income, short or long-term capital gain.
(For reporting and ordering rules refer to Form 6252 instructions, also Pub. 544)
Use Form 4797 to report the following transactions:

1. The sale or exchange of property used in a trade or business; depreciable or amortizable
property; oil, gas, geothermal or other mineral properties; Section 126 property.
2. Involuntary conversion (other than casualty and theft) of property used in a trade or
business and capital assets held in connection with a trade or business or a transaction
entered into for profit.
3. The disposition of noncapital assets.
4. The disposition of capital assets not reported on Schedule D.
5. The recapture of Section 179 for partners and S corporation shareholders from property
dispositions by partnerships and S corporations.
6. The computation of recapture amounts under Section 179 and 280F (b) (2) when business
use drops to 50% or less.
The following code sections apply when assets are sold and reported on Form 4797:
Section 1231 (Form 4797, Part I)
• Personal and real business assets
• Gains exceed the depreciation taken
• Gains are treated as long-term capital gain treatment and subsequently reported on
Schedule D
• Gains are treated as short-term capital gain treatment and subsequently reported on
Schedule D
Section 1245 (Part II or III)
• Refers to gains from personal business assets and certain commercial real estate
85
• Gains result from claimed or allowable depreciation
• Gains are treated as ordinary income
Section 1250 (Part III)
• Gains from real property
• ACRS depreciation recapture as ordinary income
• ACRS on residential building excess over straight line recaptured as ordinary income
• No recapture under MACRS because straight line depreciation always taken
• Unrecaptured Section 1250 gain-taxed as capital gains at 25% rate
Section 179 and 280(f)
• Recapture of excess depreciation when business use falls under 50%
• Recapture of Section 179 or 280(f) expense deduction allowable if the Sec 179 or
280(f) expense had not been taken
• Gains from the disposition of assets as a result of Section 179 are considered ordinary
income
Schedule D
On the next few pages is a blank Schedule D for reference and an example of the Schedule D
worksheet for a taxpayer whose regular tax rate is below 25%.
86
87
156. Most properties owned and used for personal purposes, pleasure or
investment are capital assets.
A. True
B. False
157. The following are examples of a capital asset; except:

A. Personal residence
B. Furniture
C. Supplies regularly used in the trade or business
D. Car
158. Which of the following is not considered a capital asset?

A. Stock or trade or other property included in inventory or held mainly for sale to
customers.
B. Depreciable property used in trade or business
C. U.S Government record including the Congressional Record.
D. All of the above
159. The basis of property bought is usually ________.

A. The property current value
B. The property cost
C. The property current value less the cost
D. All of the above
160. The cost of property does not include amounts paid for which the following?
A. Warranty contract bought at the time of purchase
B. Sales Tax
C. Installation and testing
D. Recording fees
161. Which of the following statements is not true?

A. Real property is also called real estate.
B. Real property is land and generally anything built on land.
C. Real property is land and generally anything attached to land
D. Land is depreciable
162. The price at which property would change hands between a willing buyer and a willing
seller, neither having to buy or sell, and both having reasonable knowledge of all the
necessary facts is the ________________ of the property.
A. Cost or basis
B. Adjusted basis
C. Fair market value (FMV)
D. Taxable exchange
88
163. The result of increases or decreases to the basis of property is which of the following?
A. Fair Market Value
B. Basis other than cost
C. Adjusted basis
164. How does an improvement having a useful life of more than 1 year and increases the
value of the property, lengthens the life of the property or adapts the property for a different
use effect the basis?
A. Increases the basis
B. Decreases the basis
C. Has no effect on the basis
165. The sale of business property is reported on Form 4797.

A. True
B. False
166. Which of the following increases the basis of property?

A. Capital improvements
B. Casualty losses- restoring damaged property
C. Zoning costs
D. All of the above
167. The following decreases the basis of property, except;

A. The section 179 deduction
B. Alternative motor vehicle credit
C. Legal fees
D. Easements
168. Basis other than cost is computed by using the fair market value or the adjusted basis.
A. True
B. False
169. Which of the following describes a taxable exchange?

A. When a gain is taxable or a loss is deductible
B. When a gain is deductible and a loss is taxable
C. Both of the above
D. Neither of the above
170. A taxable gain or deductible loss is known as which of the following?

A. Taxable exchange
B. Recognized gain or loss
171. The most common nontaxable exchange is which of the following?

A. Voluntary conversion
B. Involuntary exchange
C. Voluntary exchange
89
D. Involuntary conversion
172. A like-kind exchange is reported on which form?

A. 8824
B. 4797
C. 4562
D. 2106
173. Which of the following is the most common nontaxable exchange?

A. Bartering
B. Like-kind exchange
C. Exchange of different kinds of property
174. Qualifying property in a like-kind exchange must be held for which of the following
reasons?
A. Investment
B. Productive use in a trade or business
C. Either A or B
D. Neither A or B
175. The basis of property received as a gift is the FMV less the donor’s adjusted basis.
A. True
B. False
176. The basis of stocks or bonds generally is which of the following?

A. Fair Market Value
B. Current value
C. Purchase price plus any costs of purchase
177. When purchasing stocks or bonds, the cost of purchase can include which of the
following?
A. Commissions
B. Recording Fees
C. Transfer Fees
D. All of the above
178. Which form is issued when stocks, bonds or certain commodities are sold through a
broker?
A. 1099-MISC
B. 1098
C. 1099-INT
D. 1099-B
179. A sale is generally a transfer of property for money or which of the following?
A. Mortgage
B. Note
C. Promise to pay money
D. All of the above
90
180. A trade is a transfer of property for other property or services and may be taxed the same
way as a sale.
A. True
B. False
181. When is a security that becomes worthless during the year treated as though it was sold?
A. The day it became worthless
B. The last day of the year
C. The day after it became worthless
182. When is Form 1099-S used?

A. To report interest
B. To report dividends
C. To report a real estate sale
D. To report a pension distribution
183. Reportable real estate is defined as any present or future ownership interest in any of the
following, except;
A. Improved or unimproved land
B. Inherently permanent structures, including residential, commercial or industrial
buildings
C. A condominium unit and its accessory fixtures and common elements, including land
D. An automobile
184. Sale expenses are added to the basis.

A. True
B. False
185. A sales expense includes which of the following?

A. Commissions
B. State and local transfer tax
C. Broker’s fees
D. All of the above
186. Real estate sales expense includes the following, except:

A. Attorney fees
B. Lunch with the real estate agent
C. Title and escrow fees
D. Brokers fees and mortgage lender fees
187. If the amount realized from a sale is more than the adjusted basis, the difference is a
_________.
A. Loss
B. Advance
C. Profit
D. Gain
91
188. If the amount realized from a sale is less than the adjusted basis, the difference is a
___________.
A. Loss
B. Advance
C. Profit
D. Gain
189. The sales price from a sale or trade of property is everything received for that property.
A. True
B. False
190. If filing a joint tax return, which of the following is the allowable capital loss in the
current year?
A. $3000 or the total loss shown on Schedule D if less than $3,000
B. $5000 or the total loss shown on Schedule D if less than $5,000
C. $3000 or the total loss shown on Schedule E if less than $3,000
191. If there is a total net loss that is more than the yearly limit on capital loss deductions, the
unused part is which of the following?
A. A short or long-term loss
B. A short or long-term carryover to the next year
C. The loss can never be used
192. A long-term carryover loss that is carried to the next year will reduce that year’s:
A. Short-term gains before reducing long-term gains
B. Taxable income
C. Long-term gains before reducing short-term gains
193. Short-term gain or loss on the sale or trade of investment property held is one year or
more.
A. True
B. False
194. Section 1250 property, gains from real property is reported in which part of Schedule D?
A. Part I
B. Part II
C. Part III
D. Not on Schedule D
195. Which form is used to report capital gain distributions from mutual funds not reported
directly on Form 1040?
A. Schedule D, part II
B. Schedule B
C. Schedule A
D. Schedule E
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196. The tax on unrecaptured Section 1250 property is computed on the Schedule D
worksheet.
A. True
B. False
197. A gain or loss from a collectible is a capital gain or loss from the sale or trade of the
following held for more than 1 year, except:
A. Work of art
B. New stoneware
C. Antique
D. Gold
198. Under the provisions of Section 1202: When there is a gain on qualified small business
stock held more than 5 years, how much can be excluded from income?
A. One-half of the gain
B. All of the gain
C. One-third of the gain
D. None of the gain
199. Under the provisions of Section 1202: When there is a gain on qualified small business
stock held more than 5 years, at what percent is the taxable portion of the gain taxed?
A. 0%
B. 25%
C. 28%
D. 5%
200. If the taxpayer’s other gain and regular tax rate that would apply is lower than 25%; what
is the capital gain rate?
A. 0%
B. 15%
C. 28%
D. 5%
201. After May 6, 1997, a married couple, filing a joint return, can exclude ________ of the
gain realized on the sale of their personal residence if they meet certain conditions.
A. $250,000
B. $520,000
C. $500,000
D. None of the gain can be excluded
202. A home which is foreclosed or repossessed is a disposition?

A. True
B. False
203. Which of the following is true regarding the exclusion from gross income of a discharge
of personal residence indebtedness?
A. The taxpayer must reduce the basis even if falls below -0-
B. Form 982 must be included in the return
C. The exclusion applies from 2006 through 2020
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204. The Section 121 exclusion requires individual to meet certain conditions. Ownership and
use test states which of the following? The individual must have owned and used the home as
a principal residence for:
A. At least two out of the five years prior to the sale
B. No more than two out of the five years prior to sale
C. At lease three out of the five years prior to sale
D. All five years prior to the sale
205. Installment sales are sales of personal property (other than inventory) for which the
taxpayer will receive payments after the year of sale.
A. True
B. False
206. Each payment in an installment sale consists of:

A. Interest
B. Gain on the sale
C. Recovery of basis
D. All the above
207. Interest on an installment sale must be charged at a rate:

A. Equal to the IRS maximum
B. Decided by the seller
C. At least equal to the IRS minimum
D. Of 10 percent
208. The sale or exchange of property used in trade or business is reported on Form 9747.
A. True
B. False
209. Involuntary conversion (other than casualty and theft) of property used in a trade or
business and capital assets held in connection with a trade or business or a transaction
entered into for profit are reported on Form 4797.
A. True
B. False
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Chapter 7 - Types of IRA’s and Employer Sponsored Pension Plans
- Distributions
Refer to Chapter 10 in this publication or IRS Pub 590 for an explanation of each plan,
limitations and allowed contributions.
The following quote comes from Topic 451 released by the IRS in December 2008
“An individual retirement arrangement, or IRA, is a personal savings plan which allows you to set aside
money for retirement, while offering you tax advantages. You may be able to deduct some or all of your
contributions to your IRA. You may also be eligible for a tax credit equal to a percentage of your contribution.
Amounts in your IRA, including earnings, generally are not taxed until distributed to you. IRA's cannot be
owned jointly. However, any amounts remaining in your IRA upon your death can be paid to your beneficiary
or beneficiaries.
To contribute to a traditional IRA, you must be under age 70 1/2 at the end of the tax year. You, and/or your
spouse if you file a joint return, must have taxable compensation, such as wages, salaries, commissions,
tips, bonuses, or net income from self–employment. Taxable alimony and separate maintenance payments
received by an individual are treated as compensation for IRA purposes.
Compensation does not include earnings and profits from property, such as rental income, interest and
dividend income or any amount received as pension or annuity income, or as deferred compensation.
Please refer to Publication 590 for information on the amounts you will be eligible to contribute to your IRA
account. “
The following quote comes from Topic 309 released by the IRS in December 2008
“A Roth IRA is an account or annuity set up in the United States solely for the benefit of you or your
beneficiaries. It is an individual retirement plan. However, it differs from traditional IRAs in that contributions
are not deductible. For information on contributions and the limitations please refer to Chapter 2 of the
Publication 590, Individual Retirement Arrangements. “
The following are reported on Form 1040 Line 16a and 16b:
1. Qualified pension, profit sharing, stock bonus, money-purchase, Keogh plans etc.
• Complies with special rules imposed by Internal Revenue Code and IRS regs.
• Contributions allowed by both the employer and employee
• It cannot discriminate between certain employees
• It must be permanent
• It must satisfy minimum vesting requirements
2. Section 401(k) plans - employer controlled. Allows employee to defer compensation tax
free $15,500 in 2008, $16,500 in 2009, ($20,500 for employees over age 50 in 2008,
$22,000 in 2009).
3. Plans established by the United States, a state or political subdivision (does not include
Section 457 plans).
4. Section 457(b) plans available for certain state and local governments and entities tax
exempt under Section 501. Allows employee deferred compensation.
5. Tax-sheltered annuity plans Section 403(b) - Employee of a charitable, religious or
educational organization. Allow employee to defer compensation tax free (up to $15,500
in 2008).
6. SEP plans Section 408 (k) - anyone with S/E income, contributions treated the same as an
IRA. (20% of S/E income after SE tax deduction for self-employed with a maximum of
$46,000 for 2008).
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7. SEP IRA plans Section 408 (k)-Employees must be eligible (20% of S/E income after SE
tax deduction for self-employed with a maximum of $46,000 for 2008).
8. SIMPLE plans 408 (p) - Savings Incentive Match Plans for Employees - small employers
and self employed. Allows employees to defer compensation tax free.
Distributions
If the taxpayer did not pay any part of the employee pension or annuity and
the employer did not withhold any part of the cost from the pay, the
amounts received each year are fully taxable.
If part of the cost of an annuity represents a return of capital it is not taxable.

The rest of the amount is taxable.
Before age 59 ½ distributions from an IRA or qualified pension plan are taxable as ordinary
income (except for the part that represents a return of capital) and are subject to a 10% penalty
for early withdrawal. SIMPLE plans have a 25% early withdrawal penalty if the taxpayer has
been in the plan less than 2 years. (Form 5329)
When a taxpayer is between 59 ½ and 70 ½ distributions are taxable as ordinary income (except
the portion that represents return of capital). There is no early withdrawal penalty. The plan
participant has total control over the amounts of the distributions and the timing. No distribution
is required.
When a taxpayer is age 70½ distributions from Non-Roth IRA’s are required to begin.
Distributions are taxable as ordinary income (except the portion that represents return of capital).
Distributions can be lump-sum or periodic as long as the required minimum distribution (RMD)
is made in the year. The RMD can come from one account or several accounts.
For participants in qualified pension plans other than 5% owners the RMD rules do not apply
until the participant reaches 70 ½ or retires whichever is later. If the employee starts the
distributions later than 70 ½, the employee’s accrued benefit must be actuarially increased to
reflect the value of the benefits the employee would have received if the distributions started at
age 70 ½.
Note: Required minimum distribution rules do not apply to Roth IRA’s. Distributions from Roth
IRA’s are required after the death of the participant.
Required Minimum Distribution
The basic calculation of the RMD is determined by dividing the account balance by the
distribution period. For years after the year of death the distribution period is generally the
remaining life expectancy of the designated beneficiary. The distribution period is based on the
age of the beneficiary as of his/her birthday in the year following the owner’s death, reduced by
one year for each year that has elapsed since the owner’s death. If the beneficiary is the surviving
spouse the distribution period is based on the age of the spouse as of his/her birthday in the year
following the owner’s death, reduced by one year for each year that has elapsed since the
owner’s death. If the owner died before he/she reached 70 ½, the surviving spouse is not required
to begin distributions until he/she reached 70 ½. (Refer to Pub 575).
The “Worker Retiree and Employer Recovery Act of 2008” suspended the required minimum
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distributions for the 2009 calendar year.
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Rollovers of Pensions and IRA’s
A rollover is taking receipt of assets for up to 60 days before reinvesting in a new retirement
plan. A transfer is moving the assets directly from one custodian to another.
Qualifying Rollovers
1. From one IRA to another IRA within the 60 day period with the taxpayer taking
possession of the IRA during the 60 day period. IRA’s cannot be rolled over more than
once in a 12-month period.
2. From an employer plan to an IRA within the 60-day period with the taxpayer taking
possession of the distribution. The 60-day rule applies even if the distribution was in
error.
3. A traditional IRA can be rolled into a qualified retirement plan. Nondeductible after tax
dollars are not eligible to be rolled into an employer plan but can be rolled over form one
IRA into another IRA.
A SIMPLE IRA to a qualified retirement plan - the participant must be in the plan for 2
years. If the participant was not in the plan for 2 years the SIMPLE IRA can only be rolled
into another SIMPLE IRA.
4. From a 457 plan to a qualified retirement plan.
5. From a 403(b) annuity plan to a qualified retirement plan
6. From a deceased spouse’s plan to the surviving spouse’s qualified plan
7. Rollover of after-tax contributions provided a direct trustee to trustee transfer is made.
The taxpayer is responsible for tracking the basis on Form 8606.
A Roth IRA can be rolled over to another Roth IRA but cannot be rolled over to a traditional
IRA.
Losses on the tax-deferred portion of IRA’s, pension plans and annuities are generally not
deductible because the taxpayer has not paid tax on the money lost.
The taxable portion of a pension or annuity is determined using the simplified method if the
annuity starting date is after Nov. 18, 1996 and the participant is not 75 years or older. If the
participant is in a nonqualified plan, age 75 or older on the annuity starting date refer to Pub 939.
In order to determine the amount that is taxable under the Simplified Method the participant’s
cost must be established. The cost is everything the participant paid into the plan and taxable
contributions by the employer. Cost does not include amounts excluded from income. Refunds of
premiums, rebates, dividends, unpaid loans, or other tax-free amounts must be subtracted. The
cost should be shown in Box 5 of Form 1099-R.
Under the Simplified Method the tax-free part of each monthly annuity payment is computed by
dividing the cost by the total number of expected monthly payments. For an annuity that is
payable for the lives of the annuitants, this number is based on the annuitants ages on the annuity
starting date and is determined from a table. For any other annuity the number is the number of
monthly annuity payments in the contract. (Refer to Pub 17 or 590 for worksheet)
Lump-Sum Distributions ((Form 4972) (10-Year averaging)) is available for taxpayers born
before 1936. See instructions for Form 4972 for qualifications and ten-year averaging tables.
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Form 1099-R
Box 1 Gross Distributions
Box 2a Taxable Amount
Box 2b Check Box for Total Distribution or Taxable Amount Not Determined
Box 3 Capital gain included in Box 2a
Box 4 Federal Income Tax Withheld (Must attach 1099-R to Form 1040)
Box 5 Employee contributions, or designated Roth contributions
or insurance premiums (cost)
Box 6 Net unrealized appreciation in employer’s securities
Box 7 Distribution codes
Box 8 Value of annuity contract
Box 9 Percentage of total distribution
Box 9b Total employee contribution
Box 10 State Tax Withheld (Must attach Form 1099-R to state return)
Box 11 State/Payer’s State Number (needed to include in income of that state)
Box 12 State distribution (if different from Federal)
Box 13 Local Tax Withheld
Box 14 Name of locality
Box 15 Local distribution
Additional Taxes on Qualified Plans (including IRA’s) – Form 5329
An additional tax is due if the taxpayer received an early distribution from a Roth IRA and Form
8606 line 21 is more than Form 8606 Line 23 (See Form 8606 instructions) or an early
distribution from a qualified retirement plan other than a Roth IRA. An early distribution is
before the participant reaches age 59 ½.
The additional tax for early distributions from a qualified retirement plan is 10% unless the
distribution is from a SIMPLE IRA within the first 2 years the participant is in the plan. In that
case the penalty is 25%.
If a contribution is more than the smaller of compensation or $4,000 ($5,000 if over 50), it is
considered an excess contribution. A contribution made for the year a taxpayer turns 70 ½ or any
later year, is also an excess contribution. There is a 6% excise tax each year on excess amounts
that remain in an IRA. The excise tax will not apply if the excess is removed before the due date.
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Exceptions to the Additional Tax on Form 5329
Excerpt from Form 5329 Instructions
100
210. An individual retirement arrangement, or IRA, is a personal savings plan

which allows you to set aside money for retirement, while offering you tax
advantages.
A. True
B. False
211. Contributions to a _______ are nondeductible, and the interest earned is tax deferred.
A. IRA
B. Roth IRA
C. SEP
D. SIMPLE
212. The following are examples that are reported on Form 1040 line 16a and 16b except:
A. SEP IRA plans Section 408 (k)
B. Tax sheltered annuity plans Section 403(b)
C. Qualified pension
D. Interest from a bank
213. If the taxpayer did not pay any part of the employee pension, and the employer did not
withhold any part of the cost from the pay, the amounts received each year are _______.
A. Nontaxable
B. Fully taxable
C. Consider as Losses
D. Nondeductible
214. Before age _______ distributions from an IRA are taxable as ordinary income and
subject to a 10% penalty for early withdrawal.
A. 65
B. 55 ½
C. 59 ½
D. 60
215. When a taxpayer is age 70 ½ distributions from non-Roth IRA’s are required to begin.
A. True
B. False
216. The basic calculation of the required minimum distribution is determined by _______ the
account balance by the distribution period.
A. Subtracting
B. Adding
C. Dividing
D. Multiplying
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217. A _______ is taking receipt of assets for up to 60 days before reinvesting in a new
retirement plan.
A. Transfer
B. Rollover
C. Distributions
218. A _______ is moving the assets directly from one custodian to another.
A. Rollover
B. Distribution
C. Transfer
D. SEP
219. Losses on the tax-deferred portion of IRA’s pension plans and annuities are generally
_______ because the taxpayer has not paid tax on the money lost.
A. Taxable
B. Not deductible
C. Fully deductible
D. Discounted
220. A Roth IRA can be rolled over to another Roth IRA but cannot be rolled over to a
traditional IRA.
A. True
B. False
221. The following are exceptions to the additional tax on Form 5329, except:
A. IRA distributions made for higher education
B. Distribution due to death
C. Distribution due to total and permanent disability
D. IRA distributions made for purchase of a second home
222. Form 5329 is used to compute an additional tax in the following instances, except:
A. Early withdrawal of funds from an IRA
B. Excess contributions to an IRA account.
C. Penalty for early withdrawal from savings
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Chapter 8 - Rental Real Estate, K-1 Income and Loss, Passive
Activities
Rental Income - Pub 527
Rental income is any payment the taxpayer receives for the use or
occupation of property or a dwelling unit. A dwelling unit includes
apartments, condominiums, mobile home, boat, vacation home, or similar
property. A dwelling unit has basic living accommodations such as sleeping
space, a toilet and cooking facilities. Income from room rentals of a hotel or
motel is not considered rental income and should be reported on a Schedule C. Included in rental
income are the following items:
• Security deposits - that are kept by the property owner or landlord or used as the last
month’s rent, included in rent. Security deposits that are returned to the tenant are not
income
• Advance rent is any amount received before the period that it covers. Include advance
rent in rental income in the year it is received, regardless of the period it covers or the
method of accounting used
• Payment for canceling a lease is included in income in the year received
• Expenses paid by the tenant are rental income and can be deducted as any other rental
expense
• If property or services are received instead of money as part of the rent include the
fair market value in income. If services are agreed upon at a specified price, that price
is the fair market value
• If the tenant has a lease with an option to buy, the payments received under the
agreement are usually rental income. If the tenant exercises the right the payments
received after the date of sale are considered part of the selling price
Rental Expenses
Ordinary and necessary expenses are deductible for managing, conserving or maintaining rental
property from the time it is first available for rent. Accurate record keeping is mandatory for
expenses to be deductible. Ordinary and necessary expense can be taken when a rental is vacant,
but no losses can be deducted for the period the rental is vacant.
Repairs are considered an expense and deductible in the year they are paid. Improvements add to
the basis of the property and are depreciated. An improvement adds to the value of property,
prolongs its useful life or adapts it to new uses. The cost of an improvement must be capitalized
and can generally be depreciated as if the improvement was separate property. Repairs made
within extensive remodeling or restoration of property are included as part of the improvement
and capitalized.
Work done on the rental property that does not add much to either the value of the house or the
life of the property, but rather keeps the property in good condition is considered a repair, not an
improvement. Repainting, fixing gutters, floors, or replacing broken windows are examples of
repairs.
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The following is a list of common rental expenses:
• Advertising
• Cleaning and maintenance
• Utilities
• Insurance
• Taxes
• Interest
• Points
• Commissions
• Tax return preparation fees
• Local transportation costs
• Rental payments or leases on equipment
Mortgage interest reported to the owner of the property on Form 1098 (if over $600) is a
deductible expense. Points or “loan origination fees”, if any are charges solely for the use of the
money and are considered interest.
Insurance premiums paid in advance cannot be deducted in full in the year paid. The premium
must be allocated to the period covered and deducted in that year.
Local benefit taxes that increase the value of the property, such as charges for putting in sewers,
streets or sidewalks are non-depreciable capital expenditures and are added to the basis only.
The ordinary and necessary expenses of traveling are deductible if the primary purpose of the
trip was to collect rents, or to manage, conserve, or maintain the rental property. The travel
expenses must be properly allocated between rental and non-rental activities. (See Chapter 10, in
this text or Pub 463).
The ordinary local transportation expenses to collect rents, or to manage, conserve, or maintain
the rental property is deductible. Generally if the taxpayer uses his/her personal vehicle the
expenses can be deducted using one of two methods: actual expense or standard mileage rate.
In 2008 there are two standard mileage rates. Before July 1, 2008 the standard mileage rate is
50.5 cents; after July 1, 2008 the standard mileage rate is 58.5 cents. (Refer to Chapter 10 in this
text or Pub 463)
Condominiums and Cooperatives

Special rules apply to the rental of a condominium or cooperative.
A condominium is a dwelling in a multi-unit building. Along with owning the unit, the owner
also owns some of the common elements of the structure such as land, lobbies, elevators, and
service areas. The owners of the units may pay dues or assessments for the care of these common
areas.
If the condominium is a rental, expenses such as depreciation, repairs, upkeep, dues, interest,
taxes and assessments for the care of the common parts of the structure are deductible. Any
special assessments for improvements to the rental must be capitalized and depreciated.
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All of the maintenance fees paid to cooperative housing authority for a cooperative apartment
rented to others are deductible. Any payment for improvements or a capital asset cannot be
deducted. The payment is added to the basis of the stock in the cooperative. In addition to the
maintenance fees direct payments for repairs, upkeep and other rental expenses can be deducted.
(Refer to Pub. 527)
The personal use of a dwelling unit comes into play if a personal residence or any other property
was changed to a rental at any time during the year other than the beginning of the tax year. The
yearly expenses such as taxes and insurance must be divided between rental and personal use.
For depreciation purposes, treat the property as being placed in service on the conversion date.
If only part of a property is rented the expenses and depreciation must be divided between the
rental and personal use. Direct expenses of the rental do not have to be divided. The cost of the
first phone line cannot be deducted, but a portion of other utilities can be deducted. The most
common way to divide the expenses is either by square footage or number of rooms.
The tax treatment of rental income and expenses for a dwelling unit that is also used for personal
purposes depends on whether it is used as a home. The dwelling unit is considered a home for
tax purposes if during the year it is used for personal purposes more than the greater of:
1. 14 days …or
2. 10% of the total days it is rented to others at a fair rental price.
If a home is rented fewer than 15 days during the year, none of the rental income or expenses are
to be included. If the home is rented more than 15 days all the income and expense must be
reported, including depreciation. All expenses and depreciation must be allocated between
personal and rental use. (Refer to the passive section of this chapter for limitations of losses)
Rental income, expenses and depreciation are reported on Part I of Schedule E.
Depreciation (Form 4562)

Depreciation is the annual deduction allowed to recover the cost or other basis of
business or other investment property through yearly deductions. Depreciation
reduces the basis through yearly tax deductions. Only the part of property used for
business or rental purposes can be depreciated.
Three basic factors determine how much depreciation can be deducted each year.
1. The basis in the property
2. The recovery period for the property
3. The depreciation method used.
Depreciation starts when the property is first used in business or for the production of income. It
ends when the property is taken out of service, deduct all depreciable cost or other basis, or no
longer use the property in the business or for the production of income.
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The basis of property must be reduced by the full amount of depreciation that could have been
deducted, whether or not the depreciation was taken. The tax return can be amended if the proper
amount of depreciation was not taken each tax year.
Depreciation can be taken on property that meets all the following requirements:
• The taxpayer owns the property, even if there is debt on the property
• The property is used in a business or an income producing activity
• The property has a determinable useful life (something that wears out, decays, gets
used up, becomes obsolete or loses value due to natural causes
• The property is expected to last more than one year
• The property is not property that is placed in service and disposed of in the same year
or a Section 197 intangible
Land can never be depreciated because land never wears out, becomes obsolete or gets used up.
No deduction greater than basis may be taken. The total of the yearly deductions cannot be more
than the cost or adjusted basis of the property. The total depreciation includes the depreciation
deductions taken or was allowed to be claimed.
The type of property and the date placed in service:

1. MACRS - Modified Accelerated Cost recovery System) for property placed in service after
1986.
2. ACRS - Accelerated Cost Recovery System for property placed in service after 1980 but
before 1987.
3. Useful lives and either straight line or accelerated method of depreciation, such as declining
balance method, for property placed in service before 1981
If property was placed in service before 2008 the same method of depreciation must be
continued.
To depreciate assets placed in service in 2008 the classification of the asset or recovery period
must be determined:
3-year property includes (200% declining balance):
• A race horse that is more than 2 years old at any time it is placed in service
• Any horse other than a race horse that is more than 12 years old at the time it is
placed in service
• Any qualified rent-to-own property
• Automobiles
• Light general purpose trucks
• Typewriter, calculators, copiers etc.
• Any semi-conductor manufacturer
• Section 1245 property used in connection with research and experimentation
• Certain energy property
• Appliances, carpets, furniture, etc.
106
• Office furniture and equipment
• Railroad track
• Any property that does not have a class life and is not otherwise classified
• Vessels, barges, tubs
• Any single purpose agricultural structure
• Any tree or vine bearing fruit
• Any municipal wastewater treatment plant
• Any telephone distribution plant
• Any section 1250 property that is a retail motor fuels outlet
• Farm buildings
• Municipal sewers not classified as 25 years
25-year property includes (straight-line method):
• Property that is an integral part of the gathering, treatment or commercial use of
Municipal sewers
Residential rental property – 27.5 years (straight line method)
Nonresidential real property – 39 years (straight line method)
50-year property – improvement to roadbed or right-of-way railroad track
Report depreciation on Form 4562 and carry the deduction to the appropriate schedule. Use one
Form 4562 per business or rental.
Section 179-expense deduction is property described in Section 1245(a) (3) that was acquired
by purchase for use in active conduct of the trade or business and is either
• Tangible property that can be depreciated under MACRS or
• Off-the-shelf computer software
Section 179 does not include
• Property held for investment
• Property used mainly outside the United States
• Property used mostly to furnish lodging or in connection with the furnishing or
lodging
• Property used by a tax-exempt organization
• Property used by a governmental unit or foreign person or entity
• Air conditioning or heating units
Amortization is similar to the straight-line depreciation in that an annual deduction is allowed to
recover certain costs over a fixed time period. Amortization can be taken on such items as the
costs of starting up a business, goodwill and certain intangibles.
Listed property generally includes:

• Passenger automobiles weighing 6,000 pounds or less
• Any other property used for transportation of the nature that the property lends itself
to personal use, such as motorcycles
• Any property used for entertainment or recreational purposes
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• Cellular telephones (or other similar telecommunications equipment)
• Computers or peripheral equipment
Schedule E
Schedule E is used to report the following income or losses:
• Real estate rental activities (Page 1)
• Royalty income and expenses from oil, gas or mineral properties (Page 1)
• Income or loss from partnership’s and LLC’s that are treated as partnerships
• Required unreimbursed partnership expenses
• Income/loss from an S-corporation
• Income or loss from estates or trusts
• Income or loss from REMIC
• Net farm rental income
Classification of Activities
1. Passive activities - investment in a trade or business with no material participation
(participated more than 100 hours in the tax year or more than a total of 500 hours), most
rental activities, limited partnerships.
• There are limits on passive activity deductions and credits. Generally, income cannot
be offset by passive losses (other than passive income). Nor can taxes be offset by
income (other than passive income) with the credits resulting from passive activities.
Any excess loss or credit is suspended to the next year
• Rental real estate activities are generally considered a passive activity and the amount
of deduction allowed is limited. Active participation in rental real estate activity
allows a taxpayer with an adjusted gross income of under $100,000 to deduct up to
$25,000 ($12,500 if married filing separately) in passive losses against non-passive
income. Taxpayers are considered actively participating if they own 10% of the rental
activity and make management decisions in a significant and bona fide sense. Use
Form 8582 to compute and track passive activities and suspended amounts from year
to year
2. Non-passive activities - trade or business activate with material participation. Include wages
and SE income. A person engaged in a trade or business is not subject to passive loss rules if
material participation rules are met. Refer to Pub 925 for material participation criteria)
3. Portfolio Income - interest, dividends, and royalties from investments such as stocks, bonds
and interest bearing accounts.
Royalty Income
Royalty from copyrights, patents and oil, gas and mineral properties are taxed as ordinary
income which is generally reported on Schedule E. If the royalties are received as a self-
employed writer, inventor or artist, report the royalties on Schedule C.
Copyright and patent income is generally paid to the taxpayer for the right to use the taxpayer’s
work over a period of time. Royalties from oil and gas are paid by a person or company who
leases the property from the taxpayer. (Refer to Schedule instructions for additional information).
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Pass-through Income from Partnership, S-Corporation, Estate or Trust K-1’s
Schedule E, Page 2 is where all pass-through K-1 income or loss is reported. Partners and S
Corporation shareholders and estate or trust beneficiaries should get a separate Schedule K-1 (or
substitute statement) of income, expenses, deductions and credits for each activity engaged in by
the partnership or S-corporation. Every K-1 should have instructions regarding the correct
reporting of the partner or shareholder’s share of the items. Schedule K-1 is not attached to the
individual return.
The taxpayer may deduct unreimbursed ordinary and necessary expenses paid on behalf of the
partnership if required to pay these expenses under the partnership agreement. The K-1
instructions will tell where the income or loss is to be reported. Ordinary or rental income or loss
from a partnership, S-corporation or an estate or trust is reported on Schedule E, page 2.
If the partner is classified as a limited partner (did not materially participate in the partnership),
the income from the K-1 is also passive.
A sale of a passive activity is considered to be a nonpassive transaction. Passive activity losses

that have not been deducted in a prior year (suspended) are generally allowed in the year of
disposition. This includes the current year loss and any losses suspended from a prior year. This
rule applies if the entire entity is disposed of and the sale is not made to a related party.
Farm Income
Sources of Income Subject to SE Tax
• Sales of livestock and other items bought for resale
• Sales of livestock, produce, grains, etc. that the taxpayer raised
• Distributions received from cooperatives
• Agricultural program payments
• Custom hire work
• Federal and state fuel tax credits
Accounting Methods for Farmers

1. Cash method - income is reported when actually received or constructively received.
Expenses are deducted in the year paid.
2. Accrual method – required for certain farm corporations and partnerships, and for all tax
shelters. Report income in the year in which it was earned and expenses in the year incurred.
3. Special methods of accounting for certain items of income and expenses. Crop method is a
method used by farmers who do not complete harvesting and disposing of crops within the
tax year they are planted. The entire cost of the crop is deducted in the year the income is
realized.
4. Combination hybrid method using elements of 1, 2, and 3.
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Section 179 Deductions - Farm Property
Trade or business property that qualifies for a Section 179 deduction includes:
• Tangible personal property such as machinery and equipment, milk tanks, automatic
feeders, barn cleaners and office equipment
• Livestock
• Single-purpose agricultural and horticultural structures such as greenhouse, hay
storage, integrated hog raising facility
• Milk parlor
• Poultry house
Depreciation - Three, five, seven and ten-year MACRS property used in a farming business
must be depreciated using 150% declining-balance or SL method.
Principal Agricultural Codes - are included on page 2 of Schedule F. An activity code must be
included on all Schedule F’s to classify farms. These codes are based on the North American
Industry Classification Industry.
An election can be made to figure the tax by averaging over the previous three base years.
Making this election may provide a lower tax if the current year tax is high and in one of the
previous three years the tax is low. Farm averaging is computed on Schedule J (Refer to
Schedule J instructions).
110
223. _______ is any payment the taxpayer receives for the use or occupation of
property or a dwelling unit.
A. Rental income
B. Rental expense
C. Owners equity
D. All of the above
224. The following are samples of dwelling units except:

A. Apartments
B. Houseboat
C. Condominiums
D. Hotel room
225. Which of the following is an example of rental income:

A. Security deposit
B. Expenses paid by the tenant
C. Payment for canceling a lease
D. All of the above
226. Which of the following is not a common rental expense:

A. Interest
B. Commissions
C. Sale of land
D. Insurance
227. Which of the following is a true statement?

A. Depreciation is shown separately on each rental property.
B. Improvements made on a rental are never depreciated.
C. The basis of rental property can be taken as an expense if the taxpayer chooses.
228. Work done on the rental property that does not add much to either the value of the house
or the life of the property, but rather keeps the property in good condition is considered a
___________.
A. Repair
B. Improvement
C. A miscellaneous expense
229. Insurance premiums paid in advance cannot be deducted in full in the year paid. The
premium must be allocated to the period covered and deducted in that year.
A. True
B. False
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230. _______ is the annual deduction allowed to recover the cost or other basis of business or
other investment property through yearly deductions.
A. Depreciation
B. Capital losses
C. Utilities
D. Real estate taxes
231. Depreciation starts when the property is first used in business or for the production of
income. It ends when the property is taken out of service, deduct all depreciable cost or other
basis, or no longer use the property in the business or for the production of income.
A. True
B. False
232. Which of the following are true statements regarding depreciation?

A. No deduction greater than basis may be taken.
B. The total of the yearly deductions cannot be more than the cost or adjusted basis of
the property.
C. The total depreciation includes the depreciation deductions taken or was allowed to
claim.
D. All of the above
233. Residential rental property placed in service in 2008 has a class life under MACRS of:
A. 27.5 years – straight line
B. 39 years – straight line
C. 31.5 years straight line
234. 5-year property MACRS includes (200% declining balance) the following, except:
A. Automobiles
B. Office furniture
C. Typewriter, calculators, copiers etc.
D. Computers
235. Section 179-expense deduction is property described in Section 1245(a)(3) that was
acquired by purchase for use in active conduct of the trade or business and is either tangible
property that can be depreciated under MACRS, or:
A. Off-the-shelf computer software
B. Property held for investment
C. Air conditioning and heating unit
236. Amortization is similar to the straight-line depreciation in that an annual deduction is

allowed to recover certain costs over a fixed time period..
A. True
B. False
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237. Land can never be depreciated because land never wears out, becomes obsolete or gets
used up.
A. True
B. False
238. Modified Accelerated Cost Recovery System is for property placed in service after
_______
A. 1988
B. 1986
C. 1999
D. 1983
239. Report depreciation on Form 4562 and carry the deduction to the appropriate schedule.
Use one Form 4562 per business or rental Section 179
A. True
B. False
240. Amortization can be taken on such items as the costs of starting up a business, goodwill
and certain intangibles.
A. True
B. False
241. Rental income, rental expenses, rental depreciation, royalty income and depletion are
reported on Schedule E, page 1.
A. True
B. False
242. The dwelling unit is considered a home for tax purposes if during the year it is used for
personal purposes more than the greater of 14 days or 10% of the total days it is rented to
others at a fair rental price.
A. True
B. False
243. _______ are an investment in a trade or business with no material participation, most
rental activities, and limited partnerships.
A. Passive activities
B. Portfolio income
C. Nonpassive activities
D. All of the above
244. Which of the following is not included as a definition of a passive activity?

A. Investment in a trade or business with no material participation
B. Interest income
C. Rental activities
D. Limited partnerships
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245. Which of the following statements are true about rental real estate activities?
A. The amount of deduction allowed is limited
B. Active participation in rental real estate activity allows a taxpayer with an adjusted
gross income of under $100,000 to deduct up to $25,000 ($12,500 if married filing
separately) in passive losses against non-passive income.
C. Use Form 8582 to compute and track passive activities and suspended amounts from
year to year.
246. Portfolio income includes the following, except

A. Interest
B. Dividends
C. Royalties
D. Self-Employment Income
247. Partners and S Corporation shareholders and estate or trust beneficiaries should get a
separate Schedule K-1:
A. True
B. False
248. Which of the following information is included in the Schedule K-1?

A. Income
B. Expenses
C. Deductions and credits
D. All the above
249. The taxpayer may deduct unreimbursed ordinary and necessary expenses paid on behalf
of the partnership if required to pay theses expenses under the:
A. Corporation agreement
B. Partnership agreement
C. Handshake agreement
250. Report ordinary income or loss from a partnership, S-corporation or an estate or trust on:
A. Schedule E, page 1
B. Schedule D
C. Schedule E, page 2
D. Schedule C
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251. All of the following are reported on Schedule E, except:
A. Royalty from copyrights, patents and oil, gas and mineral properties are taxed as
ordinary income the income is generally reported on Schedule E.
B. Royalties are received as a self-employed writer inventor or artist.
C. Copyrights and patent income is generally paid to the taxpayer for the right to use the
taxpayer’s work over a period of time.
D. Royalties form oil and gas is paid by a person or company who leases the property
from the taxpayer.
252. If the partner is considered a limited partner (did not materially participate in the
partnership), the income from the Schedule K-1 is:
A. Nonpassive
B. Inactive
C. Passive
D. Submissive
253. Farm income is reported on Schedule F.

A. True
B. False
254. Which of the following is a source of income reported on Schedule F?

A. Sales of livestock and other items bought for resale
B. Sales of livestock that the taxpayer raised
C. Agricultural program payments
D. All of the above
255. Which farm property used in trade or business qualifies for a Section 179 deduction?
A. Machinery and equipment
B. Milk tanks
C. Livestock
D. All of the above
256. In a farming business, the 150% declining-balance or SL method must be used when
depreciating the following, except:
A. Three-year MACRS property
B. Fifteen-year MACRS property
C. Five-year MACRS property
D. Seven-year MACRS property
257. Principal Agricultural Codes must be included on the Schedule F to classify farms.
A. True
B. False
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Chapter 9 - Unemployment Compensation, Social Security Benefits
and Miscellaneous Income
Unemployment Compensation
Unemployment compensation is taxable and reported to the taxpayer on Form
1099-G. Unemployment compensation is not taxable to the state.
Social Security Benefits
Social Security benefits may be taxable. To find out whether any of the Social Security Benefits
received are taxable compare one-half of the benefits plus all other income including tax-exempt
with the base amount. The base amount is
• $25,000 if single, head of household or qualifying widow(er)
• $25,000 if married filing separately and lived apart from the spouse for the tax year
• $32,000 if married filing jointly, or
• -0- if married filing separately and lived with the spouse at any time during the year
Excerpt from Pub 17
If one-half of the benefits plus all other income is less

than the base amount none of the social security benefits
are taxable. If one-half of the benefits plus all other
income is more than the base amount some of the social
security benefits are taxable.
A worker is eligible for early retirement benefits at age

(62). Early retirement permanently reduces the amount
of benefits. If receiving early retirement benefits there is
an earning limit on receiving benefits. For 2008 the
earnings limit is $13,560, benefits are reduced by $1 for
each $2 earned.
Full retirement age is when a worker can retire and

collect full benefits (Age 65 and 6 months). For a person
born in 1937 or earlier the full retirement age is 65. Full
retirement will increase in gradual steps until it reaches
66 in 2009 and age 67 in 2027. If the taxpayer is over 65
when retiring he will receive full benefits.
Delayed retirement is available for a worker over the

full retirement age. At age 70 the worker automatically
starts receiving benefits. Benefits are increased by a
monthly percentage if the worker delays retirement.
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If a taxpayer, spouse or dependent does not have a Social Security Number refer to the Social
Security Administration website at www.ssa.gov or phone 1-800-772-1213 to apply.
(Refer to Pub 517)
Miscellaneous Income – Line 21 Form 1040
Hobby income or not-for-profit income is income that must be reported and
accurate records must be kept, according to generally accepted accounting
practices. Expenses are allowed to be deducted from this income. The expenses
are limited to the amount of income. Refer to Pub 535 for information of
whether income is not-for-profit and more information.
Alaska Permanent Fund dividend income, the taxable amount is stated with each check and
reported to the IRS.
Credit card insurance under a credit card disability or unemployment insurance plan is taxable.
Nonemployee compensation - usually reported on 1099-MISC, fees may be subject to self-

employment tax.
Executor or administrator of an estate income may be subject to self-employment tax.
The following items are taxable and must be reported on line 21 of Form 1040:
Kickbacks
Jury duty
Illegal income
Prizes and awards
Items not considered miscellaneous income for tax purposes

• Cash rebates – from manufacturers or dealers
• Casualty insurance and other reimbursements (refer to Pub 547)
• Damages received for emotional distress due to physical injury or sickness
• Foster care payments are generally not taxable
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258. Which of the following is a true statement regarding unemployment

compensation?
A. Reported to the taxpayer on Form 1099-G and is not taxable.
B. Reported to the taxpayer on Form 9910-G and is taxable.
C. Reported to the taxpayer on Form 1099-G and is taxable.
D. Unemployment compensation is never taxable.
259. All of the following is true regarding Social Security, except:

A. Delayed retirement is available for a worker over the full retirement age.
B. For a person born in 1937 the full retirement age is 66.
C. At age 70 a worker loses social security benefits
D. There is an earnings limit if a worker chooses early retirement.
260. A worker is eligible for early retirement benefits at:

A. Age 59 1/2
B. Age 62
C. Age 63
D. Age 65
261. How does early retirement affect the amount of the Social Security benefits paid?
A. Has no effect
B. Permanently reduces the amount paid and places an earning limit on receiving
benefits
C. Permanently reduces the amount paid, but allows you to earn income without effect
D. Increases the amount of the benefit paid
262. Hobby income is:

A. Income that must be reported and accurate records must be kept
B. Expenses are allowed up to the amount of income
C. Not for profit income
D. All of the above
263. Which of the following items is generally not taxable?

A. Prizes and awards
B. Jury duty
C. Illegal income
D. Foster care payments
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Chapter 10- Adjustments to Income
If the taxpayer is an eligible educator in 2008 they can deduct up to $250 of qualified expenses
paid as an adjustment to income rather than as an itemized deduction. Extenders
legislation allowed this deduction in 2008. It is reported on line 23 of Form
1040, the same line as Archer MSA.
Educators must file Form 1040 in order to take the deduction for up to $250 of
out-of-pocket classroom expenses. It cannot be claimed on Form 1040A. The
adjustment for educator expenses is claimed on Form 1040, line 23.
Form 1040, line 24 is where a adjustment for certain business expenses of reservists,
performing artists and fee-based government officials are reported. Reservists have now been
added to the special rules allowing an adjustment for these expenses rather than an itemized
deduction like other employee business expenses. These adjustments are computed on Form
2106, like other business expenses. (Refer to Pub 463 for more information.) The adjustment
coming from Form 2106 for reservists, performing artists and fee-based government employees
is claimed on Form 1040, line 24.
Health Savings Account

A health savings account (HSA) is a tax-exempt trust or custodial account that is set up with a
U.S. financial institution (such as a bank or an insurance company). Health Savings Accounts are
designed to allow the taxpayer to save for current and post-retirement qualified medical expenses
on a tax free basis. This account must be used in conjunction with a high deductible health plan
(HDHP). The adjustment for health savings account is claimed on Form 1040, line 25.
The HSA can be established using a qualified trustee or custodian that is different from the
HDHP provider. Contributions to an HSA must be made in cash or through a cafeteria plan.
Contributions of stock or property are not allowed.
Benefits of an HSA:
• The HSA is tax deductible even if the taxpayer is not itemizing
• Contributions made by the employer (including contributions through a cafeteria
plan) may be excluded from gross income
• The contributions remain in the account from year to year until used
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• The interest or other earnings on the assets in the account are tax free
• Distributions are tax free if used for qualified expenses
An HSA is portable and stays with the taxpayer. Contributions to an HSA are generally limited
to the maximum allowable deduction for the year or the HDHP annual deductible. Individuals
age 55 or over are allowed catch up contributions.
Moving expenses are reported on Form 3903. Moving costs are allowed for
moving household goods and personal effects and travel expenses for one trip
for the taxpayer and each member of the household. Household members
do not have to travel together or at the same time. The standard mileage
rate for moving expenses is 19 cents per mile before July 1, 2008 and 27
cents per mile after June 30, 2008. The adjustment for moving expenses is claimed on Form
1040, line 26.
To file Form 3903 the taxpayer must meet the following general rules:
• The taxpayer must move within the U.S. or be an U.S. citizen
• The distance test is met if the new place of work is at least 50 miles farther from the
former home than the old main job location was
• The employee must work at the new job for at least 39 weeks to qualify, for married
filing joint returns only one spouse needs to work
If there is any self-employment income compute Schedule SE first and then deduct ½ of the self-
employment tax on line 29.
Self-employed SEP, SIMPLE and qualified plans (Refer to Pub 560).

• A SEP is an IRA or a group of IRA’s. The employer can make contributions to the
IRA on behalf of the employees. Self-employed persons can deduct 25% of wages up
to $46,000 for 2008 (20% of net self-employment income after SE tax adjustment).
• SIMPLE – Savings incentive match plans – Employee elective deferrals the lesser
for 2008 of earned income or $10,500 (2009, $11,500); if over 50 the lesser of
$13,000 for 2008 or earned income (2009, $14,000). The employer matches up to 3%
of wages
• Money-purchase/Defined contribution plan Contributions per participant up to the
lesser of 100% of earned income or $46,000 for 2008 with a compensation limit of
$225,000. Employer deduction limited to 25% of aggregate compensation for all
participants (20% of net SE income as SE tax deduction)
A self-employed health insurance deduction is deductible if the taxpayer was self-employed
and had a net profit or the taxpayer received wages from an S-corporation in which the taxpayer
was a 2% shareholder. The insurance plan must be established under the business and there must
be net profit equal to or more than the self-employed health insurance premiums. (Refer to Pub
535). The adjustment for self-employed health insurance is claimed on Form 1040, line 29.
Enter the penalty on early withdrawal from savings or certificate reported on Form 1099-INT
or 1099-OID. This amount does not get deducted from taxable interest. The adjustment for
penalty on early withdrawal is claimed on Form 1040, line 30.
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Alimony Paid
Alimony is a payment to or for a spouse or former spouse under a divorce or separation
instrument. It does not include voluntary payments not in the decree. Alimony is deductible by
the payer and must be included in income by the payee.
Payments not alimony:
1. Child Support
2. Noncash property settlement
3. Payments that are the spouses part of community property
4. Payment’s to keep up the payer’s property
5. Use of property
Payments included as alimony
• Payments to a third party
• Life insurance premium
• Payments for a jointly-owned home
• Mortgage payments
• Taxes and Licenses
Only the taxpayers share (1/2) of payments for a jointly owned home, mortgage interest and
taxes and licenses can be deducted as alimony. The spouse’s Social Security Number must be
provided; there may be a $50 penalty and the deduction may be disallowed. The adjustment for
alimony paid is claimed on Form 1040, line 31. (Refer to Pub 504)
IRA
Line 32, Form 1040 – If the taxpayer made contributions to a traditional IRA for 2008, they may
be able to take an IRA deduction, if there is earned income (including alimony received and self-
employment income) and meets the other requirements. Traditional IRA contributions are the
lesser of $5,000 for 2008 ($6,000 if age 50 or older in 2008) or taxable compensation.
Qualifications for a traditional IRA include:

• Must not be over 70 ½ by the end of the tax year
• Must have earned income (if married filing jointly a spouse can make contributions
based on the other spouse’s earned income - Spousal IRA)
• No gross income limitations for individuals who are not participating in a qualified
plan
• If taxpayer is in a qualified plan (active participant in an employer retirement plan),
contribution is subject to phase out of modified adjusted gross income
o Married filing jointly or qualified widow(er) the phase out is between $85,000
and $105,000 in 2008; ($89,000 - $109,000 in 2009)
o Single and H of H the phase out is between $53,000 and $63,000 in 2008;
($55,000 - $65,000 in 2009)
o -$0-to $10,000 for married filing separate
• All distributions are taxable
121
Qualifications for a Spousal IRA include:
• Must not be over 70½ by the end of the tax year
• Must have earned income (spouse can make contributions based on the taxpayers
income)
• No gross income limitations for individuals who are not participating in a qualified
plan
• If working spouse is in a qualified plan (active participant in an employer retirement
plan), the non-working spouse’s contribution is subject to phase out rules
o AGI between $159,000 and 169,000 in 2008; ($166,000 - $176,000 in 2009)
• All distributions are taxable
A Roth IRA is an individual retirement arrangement that except as explained in this chapter is
subject to the rules that apply to a traditional IRA with exception of the 70½ age rule for required
distribution. The age rule does not apply to Roth IRA’s. The IRA can be either an account or
annuity. Roth IRAs can be set up anytime during the year, generally the taxpayer can contribute
to a Roth IRA if they have compensation and their modified adjusted gross income is less than:
• $169,000 for married filing jointly or qualifying widow(er) ($176,000 for 2009)
• $10,000 for Married filing separately and lived with the spouse during the year
• $116,000 for taxpayers filing single, head of household or married filing separately, if
the taxpayer did not live with the spouse during the year ($120,000 for 2009)
Roth IRA’s are not deductible. Distributions from Traditional IRA’s are taxable upon
distribution, with Roth IRA’s only the interest earned is taxable. Roth IRA can convert to a
traditional IRA, but is taxable upon conversion as ordinary income. After conversion all
traditional IRA rules apply (Refer to Chapter 6 of this text or Pub 590).
Student Loan Interest is deductible (up to $2,500) if the taxpayer meets the
following restrictions:
• The taxpayer cannot be a dependent on another return
• Not available for married filing separate taxpayers
• The taxpayer must have the primary obligation to repay the loan
• Interest on a loan from a related party does not qualify
• Loans made under a qualified employer
plan do not qualify for the deduction
• The deduction is phased out for 2008
when modified AGI is less than $70,000
($140,000 MFJ)
Qualified loans are loans for tuition, fees, room and
board, books, equipment and transportation paid for
attendance at an eligible institution. The adjustment
for student loan interest is be claimed on Form 1040,
line 33.
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Tuition and fees deduction can be taken if all of the following apply:
• Qualified tuition and fees were paid for the taxpayer, spouse or dependent
• The filing status on the return is any filing status other that married filing separately
• The modified adjusted gross income is not more than $80,000 for single, head of
household, qualifying widow(er); $160,000 if married filing joint
• The taxpayer cannot be claimed as a dependent on another return
• There cannot be an education credit for the same return
• The taxpayer must be a U.S. citizen
Form 8917 is used to compute the allowable deduction and reported on Form 1040, Line 34.
Qualified tuition and fees do not include the following:

• Room and board
• Course related books
• Any course involving sports, games or hobbies
Qualified tuition and fees must be reduced by the following:

• Excludable U.S. series EE bonds
• Nontaxable qualified state tuition programs
• Nontaxable earnings from education savings account
• Any scholarship, educational assistance or other payment
Taxpayers must file Form 1040 to take this deduction for up to $4,000 of tuition and fees paid to
a post-secondary institution. It cannot be claimed on Form 1040A. The adjustment for tuition
and fees is claimed on Form 1040, line 35.
Domestic Production Activity Deduction – Form 8903

The American Jobs Creation Act of 2004 added the domestic production activities deduction, a
tax benefit for certain domestic production activities. This deduction provides a tax savings
against income attributable to domestic production activities. The Act created new Internal
Revenue Code section 199 and is available to corporations, individuals, and pass-thru entities
such as S Corporations, partnerships, estates and trusts. For the pass-thru entities, the deduction
is applied at the individual partner, shareholder, or similar level.
For 2008, the deduction equals 6% of the lesser of: (a) qualified production activities income; or
(b) taxable income for the taxable year. However, the deduction for a taxable year is limited to
50 percent of the W-2 wages paid by the taxpayer during the calendar year that ends in such
taxable year.
123
Enter any other miscellaneous deductions and identify each deduction on the dotted
line on line 36. Some of these deductions are:
• Jury Duty Pay (if pay turned over to employer)
• Deductible expenses related to income reported on line 21 from
rental of personal property engaged in for profit. Identify as “PPR”
• Reforestation amortization. Identify as “RFST”
• Contributions to Section 501(c) (18)(d) pension plan. Identify as Section 501
(c)(18)(d)
• Contributions by certain chaplains to Section 403(b) plans. Identify as Section 403(b)
plans
125
264. An eligible educator can deduct _____________as an adjustment to

income rather than as an itemized deduction.
A. Mileage to and from school
B. All expenses having to do with education
C. Up to $250 of qualified expenses
D. All of the above
265. Reservists have been added to the special rules allowing an adjustment to income.
A. True
B. False
266. The Health Savings Account is designed to allow the taxpayer to save for current and
post retirement _______________________ on a tax free basis
A. Qualified medical expenses
B. Charitable contributions
C. Health insurance premiums
267. Which of the following is not true regarding contributions to an HSA

A. Contributions may be made in cash
B. Contributions may be made through a cafeteria plan
C. Contributions may be made by contribution stock to the plan
D. All of the above
268. Benefits of an HSA include all the following, except.

A. The HSA is tax deductible even if the taxpayer is not itemizing
B. Contributions made by the employer (including contributions through a cafeteria
plan) may be excluded from gross income
C. The contribution must be removed at the end of each year
D. Distributions are tax free if used for qualified expenses
269. A health savings account is portable and stays with the taxpayer
A. True
B. False
270. A Health Savings Account (HSA) is set up with

A. The employer
B. The insurance provider
C. A U.S. financial institution
D. The health care provider
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271. The 2008 standard mileage rate for moving expenses prior to July 1, 2008 is
A. 10 cents per mile
B. 19 cents per mile
C. 12½ cents per mile
D. 22 cents per mile
272. Travel expenses for moving are limited to one trip for each member of the household
A. True
B. False
273. When filing Form 3903, the taxpayer must meet some general rules. Which rule is
correct?
A. The taxpayer must move within the U.S. or be a U.S. citizen
B. The new job location is at least 50 miles farther from the former home than the old
place of work
C. The employee must work at the new job for at least 39 weeks.
D. All of the above
274. One-half of Social Security wages are deductible from income

A. True
B. False
275. Which of the following are correct regarding a self-employed SEP IRA for 2008
A. The taxpayer can deduct 25% of wages up to $46,000
B. The taxpayer can deduct 20% of self-employment income up to $42,000
C. The compensation limit is $175,000
D. None of the above are correct
276. Which of the following are correct for a 2008 SIMPLE IRA
A. The employee elective deferral equals the lesser of $10,500 or earned income
B. The employer must match up to 3% of wages
C. If over 50 the lesser of $13,000 or earned income
D. All of the above
277. Self-employed health insurance is deductible if

A. The taxpayer has established an insurance plan under the business
B. The business has a net profit of at least $500
C. The taxpayer was a 50% shareholder in an S-corporation
D. The taxpayer is self-employed and the business had a net loss
278. Which does not qualify as alimony?

A. Child support
B. Payments to keep up the payer’s property
C. Use of property
D. All of the above
127
279. Which qualifies as alimony?
A. Noncash property settlement
B. Use of property
C. Life insurance premium
280. Which payments cannot be included as alimony?

A. Payments to a third party
B. Mortgage payments
C. Taxes and licenses
D. Use of property
281. The taxpayer can deduct as alimony one-half of

A. Mortgage interest of a jointly owned home
B. Mortgage principal of a jointly owned home
C. Both of A and B
D. Neither A or B
282. Qualifications for a spousal IRA include all the following except
A. All distributions are taxable
B. A non-working spouse’s contribution is subject to phase out rules
C. No gross income limitations apply if the other spouse is not in a qualified plan
D. All of the above
283. A Roth IRA is an individual retirement arrangement that except as explained in this
chapter is subject to the rules that apply to a traditional IRA with exception of the 70½ age
rule for required distribution
A. True
B. False
284. Deductible traditional IRA contributions for 2008 are

A. The lesser of $5,000 or taxable compensation
B. $6,000 if age 50 or older
C. Both A and B above
D. Neither A or B
285. Qualifications for a traditional IRA include

A. Must be at least 55 years old
B. Must not be over 65 years old
C. Must not be over 70½ years old by the end of the tax year
D. Must not be over 70½ years old by the filing due date
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286. 2008 IRA contributions are subject to phase out rules if the taxpayer is in a qualified plan
A. Phase out is between $85,000 and $105,000 for MFJ
B. Phase out is between $53,000 and $63,000 for Head of Household
C. Phase out is between $0 and $10,000 for married filing separate
D. All of the above are true
287. The taxpayer must be at least 70½ by the end of the tax year to qualify for a spousal IRA
A. True
B. False
288. In a Roth IRA the

A. Traditional IRA age rule does not apply
B. Contribution is not deductible
C. Distribution less interest is not taxable
D. All of the above
289. Student loan interest is deductible for a single taxpayer if

A. The taxpayer is not a dependent on another tax return
B. Married filing separate
C. The loan is from a relative
D. The modified AGI is above $70,000
290. A qualified student loan is a loan for

A. Equipment and school uniforms
B. Transportation and meals
C. Tuition and books
291. Tuition and fees deduction cannot be taken if

A. Filing status is Head of Household
B. Modified AGI is $65,000 or less
C. There is an education credit for the same return
D. The qualified tuition and fees were paid for the taxpayer, spouse, or dependent
292. Qualified tuition and fees include courses involving sports, games or hobbies
A. True
B. False
293. Jury Duty pay is a miscellaneous deduction for line 36 of Form 1040 if turned over to
employer
A. True
B. False
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294. Miscellaneous deductions for line 36 of Form 1040 are
A. Jury Duty Pay (if not reimbursed by employer)
B. Reforestation amortization
C. Both A and B
D. Neither A or B
295. Contributions to Section 501 (c )(18)(d) pension plan are a misc. deduction for line 36 of
Form 1040
A. True
B. False
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Chapter 11 – Itemized Deductions
Standard Deduction vs. Itemized Deductions
Refer to Chapter One
in this text to see a
listing of standard
deductions for 2008.
Enter the greater of
itemized deductions
or the standard
deduction.
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Itemized Deductions
Excerpt from Pub 17
If the adjusted gross income is above a certain amount,
the itemized deductions are reduced or phased out. In
2008, this amount is $159,950 ($79,975 if married filing
separately); in 2009 this amount is $166,800 ($83,400 if
married filing separately). Refer to Pub 502.
Medical and Dental Expenses

The part of medical and dental expenses that exceeds 7.5% can be deducted to the extent
they were not reimbursed. The following are some examples of medical and dental
expenses that can be deducted:
• Insurance premiums for medical and dental care
• Prescriptions, medicines, insulin
• Acupuncturist, chiropractor, dentist, eye doctor, medical doctors, occupational
therapist, osteopathic doctors, physical therapists, podiatrists, psychiatrists,
psychoanalysts (medical care only), and psychologists
• Medical examinations, x-rays, laboratory services, insulin treatment, and whirlpool
baths the doctor ordered
• Nursing help
• Hospital care
• A program to stop smoking, for prescription medicines to alleviate nicotine
withdrawal
• A weight loss treatment for a specific disease (including obesity) diagnosed by a
doctor
• Medical treatment for alcoholism
• Medical aids such as eyeglasses, contact lenses, hearing aids, braces, crutches,
wheelchairs and guide dogs
• Surgery to improve vision
• Lodging expenses while away from home to receive medical care in a hospital
• Ambulance service
• Long-term care premiums (See Schedule A instructions for limitations).
Any insurance reimbursement must be subtracted from the expenses.
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Taxes
Individual taxpayers have the option of claiming deduction on Schedule A for
either (1) general sales and local sales taxes; or (2) state and local income taxes.
Sales taxes can be deducted either as
• Actual sales tax amounts (based on the taxpayer’s records); or
• Predetermined deduction amounts from IRS tables.
The option to claim state and local general sales tax as a deduction has been extended two years,
through 2009.
State and local income taxes that may be deducted include the following:
• State and local income taxes withheld on Forms W-2’s or 1099’s
• State and local income taxes paid for a prior year
• State and local estimated tax payments made in the taxable year
• State and local tax refunds applied to the current year tax
• Mandatory contributions to State Disability Insurance (SDI) or Supplemental
Workmen’s Compensation Fund
Real Estate Taxes (property taxes) from state, local or foreign sources based on the assessed
value of the home are deductible in the year it is paid to the taxing authority. Do not include
charges for improvements that increase the value of the property, they are an addition to the basis
of the property. Do not include itemized charges for specific services. Real estate assessments
are deductible if they are made uniformly on property throughout the community
and if the proceeds are used for the general community.
The 2008 Housing Act provides a deduction for non-itemizers for real property
tax paid by taxpayers who do not itemize deductions. The real property tax
deduction is a maximum of $500 ($1,000 for married filing jointly) and applies to
the amount paid in 2008 and not deducted elsewhere on the return. The real property deduction is
added to the standard deduction reported on Line 40 and the checkbox on Line 39c of Form
1040.
Annual personal property taxes based on the value of the asset are deductible. For example car
registration is generally assessed against the value of the vehicle and the weight. The portion that
is based on value is deductible; the other portion based on weight is not deductible.
Other taxes such as taxes paid to a foreign country or U.S. possession. List the type of the tax
on line 8 of Schedule A.
Recoveries - A recovery is a refund of an amount that was deducted in a prior year. The most
common recovery is the state tax refund which was deducted in a prior year, discussed earlier.
Recoveries must be reported up to the amount that the taxpayer received benefit. If the taxpayer
paid back an item previously deducted that is also a recovery.
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Interest
Home mortgage interest is any loan that is secured by the main home or second home. It
includes first and second mortgages, home equity lines and refinancing
mortgages. A home must provide basic living accommodations including
sleeping space, toilet and cooking facilities. Home mortgage interest is
generally reported on Form 1098.
Limits apply to home mortgages taken out after October 13, 1987 that total more
than $100,000 may be limited. The limitations apply to mortgages where the proceeds are used
for purpose other than to buy, build or improve the main home (known as home equity debt).
Limits may also apply to home mortgages taken out after October 13, 1987 that total over
$1,000,000 used to buy, build or improve the main home. (Refer to Pub 936).
Points or loan origination fees and mortgage interest are reported to the taxpayer on Form 1098.
If the recipient is an individual, the taxpayer must include the recipient’s Social Security
Number. If points are reported on settlement papers rather than on Form 1098, report the points
on Line 12 of Schedule A. Points are fully deductible in the year paid if identified clearly on the
settlement papers and are a percentage of the principal amount.
Generally, if points are charged when refinancing they are deductible over the life of the loan
with the remaining portion deductible when the mortgage is paid off.
Mortgage Insurance Premiums – Mortgage insurance premiums paid or accrued in 2008 in

connection with acquisition indebtedness on a taxpayer’s primary or second home are deductible
as personal interest. Mortgage interest points are reported on Form 1098. The deduction is not
available for taxpayers with an adjusted gross income is more than $109,000 ($54,500 if married
filing separately)
Investment Interest
Investment interest is interest paid by the taxpayer on money borrowed that is allocable to
property held for investment. It does not include any interest allocable to passive activities or to
securities that generate tax-exempt interest income. Investment interest is reported on Form 4952
and carried to Schedule A.
Gifts to Charity
Contributions may be in cash (keep canceled checks, receipts or other reliable
documentation). Out of pocket expenses incurred when doing volunteer work
for a charitable organization is deductible. If the taxpayer drove to and from
volunteer work, they may deduct either 14 cents per mile or the actual cost of
gas and oil. Parking and tolls are also included.
Gifts that include a benefit to the taxpayer are deductible only to the extent of the donation. For
example the taxpayer paid $70 for a charitable dinner, the dinner was valued at $40. The
deductible portion of the $70 is $30.
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Gifts of $250 or more are deductible only if there is a statement issued by the charitable
institution indicating the amount of the gift and whether the organization did or did not give any
goods or services in return for the donation. In computing whether a charitable donation is over
$250 treat each donation separately. For example, if the taxpayer gives a church $25 a week
totaling $1,300 treat each $25 as a separate gift. (Refer to Pub 526)
Limits on charitable Contributions apply when the contributions exceed 50% of the adjusted
gross income. Charitable organizations classified as 50% organizations are most of the common
charitable organizations such as churches, religious organization hospitals, medical research,
schools etc. A reduced limit of 30% (capital gain property and any organization not listed as a
50% organization such as veteran’s organizations) and 20% (capital gain property donated to an
organization that is not a 50% organization).
If a charitable donation exceeds the AGI limit in the current year the remaining portion must be
carried over to each of the five subsequent years. Carryovers retain the original percentage
limits and are deducted after deducting the contributions for the current year.
Gifts other than by cash or check, of property such as clothing or furniture are deducted at the
fair market value. The fair market value is what a willing buyer would pay a willing seller when
neither has to buy or sell and both are aware of the condition of sale. (Refer to Pub 561).
If the deduction is more than $500 the taxpayer is required to file form 8283. If the total
deduction is over $5,000 appraisals on the value of the donation may be required.
Casualty and Theft
The standard deduction is increased by the excess of
the taxpayer’s personal casualty losses attributable
to federally declared disaster over personal casualty
gains. An ongoing list of Federally Declared
Disaster Areas is available through the Federal
Emergency Management Agency (FEMA) website
at www.fema.gov.
To compute a casualty or theft loss, complete and attach Form 4684. Non-business casualties or
thefts are deductible if each separate casualty or theft exceeds $100 and the total amount of all
losses during the year is more than 10% of the adjusted gross income for the year.
Casualty or theft losses include losses caused by theft, vandalism, fire, storm or similar
circumstances and car, boat or other accidents. Insurance reimbursements reduce the amount of
loss.
135
Job Expenses and Other Miscellaneous Deductions
Job expenses and other miscellaneous deductions must exceed 2% of the adjusted gross
income.
The following unreimbursed employee expenses may be deducted if they were paid
or incurred during the tax year, for carrying on the trade or business of being an
employee and the expenses were ordinary and necessary.
• Safety equipment
• Union dues
• Uniform required by employer
• Protective clothing
• Physical examinations required by employer
• Dues to professional organizations or chambers of commerce
• Legal fees related to the job
• Job search expenses
• Tools used for work
• Licenses and regulatory fees
• Malpractice Insurance premiums
• Medical examinations required by the employer
• Subscription to professional journals
• Fees to employment agencies when looking for a new job
• Certain business use of home
• Certain education expenses
• Unreimbursed employee business expenses include ordinary and necessary job
expenses paid for by the taxpayer and not reimbursed. An ordinary expense is one
common for the industry of employment of the taxpayer. If the taxpayer claims any
travel, transportation, meal or entertainment expenses for the job or the employer
paid for any job expenses Form 2106 is required
Form 2106 - Employee Business Expenses
The taxpayer cannot deduct ordinary expenses which are common and accepted for travel
(including meals unless the standard meal allowance is used) entertainment, gifts, or use of the
car or other listed property unless proper record keeping and journals of expenses are kept.
Generally receipts are required for all lodging expenses (regardless of the amounts) and any
other expense of $75 or more.
Special rules apply for qualified performing artists, fee-basis state or local government
employees or reservists (Refer to Chapter 9 in this text).
Officials paid on a fee basis. Certain fee-basis officials can claim their employee business
expenses whether or not they itemize their other deductions on Schedule A (Form 1040). Fee-
basis officials are persons who are employed by a state or local government and who are paid in
whole or in part on a fee basis. They can deduct their business expenses in performing services in
that job as an adjustment to gross income rather than as a miscellaneous itemized deduction.
136
Expenses of certain performing artists. If the taxpayer is a performing artist, they may
qualify to deduct employee business expenses as an adjustment to gross income rather than as a
miscellaneous itemized deduction. To qualify, all of the following requirements must be met.
• During the tax year, the taxpayer performs services in the performing arts as an
employee for at least two employers
• The taxpayer receives at least $200 each from any two of these employers
• The related performing-arts business expenses are more than 10% of the gross income
from the performance of those services
• The adjusted gross income is not more than $16,000 before deducting these business
expenses
Armed Forces reservists traveling more than 100 miles from home. If the taxpayer is a
member of a reserve component of the Armed Forces of the United States and travels more than
100 miles away from home in connection with performance of services as a member of the
reserves, the taxpayer can deduct travel expenses as an adjustment to gross income rather than as
a miscellaneous itemized deduction. The amount of expenses which are deductible as an
adjustment to gross income is limited to the regular federal per diem rate (for lodging, meals, and
incidental expenses) and the standard mileage rate (for car expenses) plus any parking fees, ferry
fees, and tolls
Meals and entertainment are deductible if the meal or entertainment expense is directly related
to or associated with the active conduct of a trade or business or for the
production or collection of income. Meals with business partners are
usually not deductible unless the taxpayer can establish a clear business
purpose. Lavish and extravagant expenses are not allowed, the expenses
must be reasonable according to the circumstances.
The deduction for meals and entertainment is limited to 50% of the amounts that would
otherwise be eligible. Taxes and tips, cover charges and parking are included in the 50% limit.
The following items are not included in the 50% limit:
• De minimis fringe benefits
• Expenses for meals and entertainment that are treated as taxable compensation to the
employee and fully deductible by the employer
• Promotional activities made available by the taxpayer to the general public
• Employer-provided expenses for the benefit of employees that are not highly
compensated, such as company picnics
• Meals and entertainment sold to customers such as a restaurant
Business gifts made in the course of a taxpayer’s trade or business are limited to $25 to any one
individual per year. Exceptions to the $25 business gift rule includes items costing $4 or less
containing and imprint; signs, displays, racks or other promotional items; incidental costs, such
as engraving; awards of tangible property costing $400 or less given an employee for length of
service.
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Travel away from the tax home expenses are 100% deductible if the taxpayer is away long
enough that it cannot be reasonable to expect the taxpayer to complete the trip without sufficient
sleep and rest. The tax home is determined by the taxpayer’s business being in the same general
vicinity of the main residence; the taxpayer incurs duplicate expenses while on business travel;
and the taxpayer has not changed his/her historic place of main residence.
Travel expenses include the following:

• Transportation
• Transportation to and from airports etc
• Baggage and shipping
• Car
• Lodging and meals (at 50%)
• Dry cleaning and laundry
• Telephone
• Tips
• Other similar, ordinary and necessary expense
Expenses for temporary employment away from home are deductible, when the time of
employment exceeds one year, it is considered permanent and is not deductible. Excess
reimbursement to an employee must be included in income.
There are two ways to compute the amount of vehicle expense taken on a return,
either actual expenses or the standard mileage rate. Automobiles are listed
property and are subject to rules under Internal Revenue Code Section 280(f).
Regardless of which method the taxpayer uses to compute the automobile
expenses the taxpayer must keep records of the following information:
• Total miles driven in the year
• Total business miles driven in the year
• The basis of the vehicle
• Date placed in service
The standard mileage rate can be used for either a leased vehicle or an owned vehicle. If the
standard mileage rate is used for a leased vehicle, it must be used for the entire lease period. To
compute the deductible expenses using the standard mileage rate multiply the SMR by the
number of business miles driven during the tax year. Parking fees and tolls can be taken in
addition to the standard mileage rate. The standard mileage rate for 2008 is 50.5 cents prior to
July 1, 2008 and 58.5 cents after June 30, 2008.
Actual car expenses include the following:

• Depreciation
• Garage Rent
• Gas
• Lease payments
• Licenses
• Oil
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• Parking Fees
• Registration Fees
• Repairs
• Tires
• Tolls
The actual expense method can be taken on lease vehicles. Lease payments can be deducted for
business purposes. If the lease payment is for more than 30 days, an inclusion amount is
required, refer to Pub 463 for inclusion tables.
Recordkeeping
Generally there must be documentary evidence to prove expenses, such as receipts, canceled
checks, or bills to support the deduction. If there is an accountable plan through the employer
evidentiary documentation is not required, or the expense, other than lodging, is less than $75 or
a transportation expense where a receipt is not readily available. An accountable plan is an
employer reimbursement plan for an employee’s business expenses that are deductible to the
employer and are not included in the employee’s income. The employee must substantiate the
expenses and return any excess reimbursements in a reasonable amount of time.
Documentary evidence ordinarily will be considered adequate if it shows the amount, date, place
and essential character of the expense. A canceled check together with a bill from the payee
establishes cost. The records should be kept in a timely method and provide a written statement
of the business purpose.
Form 2106 is completed and the total of the expenses are reported on Schedule A line 20 subject
to 2% of adjusted gross income. Excess reimbursements are included on Line 7 of Form 1040.
Business expenses for self-employed persons are reported on Schedule C and reduce the amount
of self-employment tax. The same limits apply for automobiles and other business expenses as
employee business expenses.
Qualifying work-related education can be deducted as a business expense. The education must
meet at least one of the following two tests
The education is required by the employer or the law to keep the taxpayer’s present salary status
1. The required education must serve a bona fide business purpose of employment.
2. The education maintains or improves skills needed in the present work.
Even if the education meets one or both of the above tests, it is not qualifying education if it:
• Is needed to meet the education requirements of the taxpayers present job
• Is part of a program of study that will qualify the taxpayer for a new trade or
business?
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Deductions Subject to 2% of Adjusted Gross Income
Income that is used to produce or collect income that must be included in gross income, to
manage conserve or maintain property held for the production of income or to determine contest,
pay or claim a refund of any tax are reported on Line 22 of Schedule A. The following items are
subject to the 2% of adjusted gross income limitation:
• Tax preparation fees
• Excess deductions of an estate
• Fees to collect interest and dividends
• Hobby expenses
• Indirect deductions of pass-through entities
• Investment fees and expenses
• Legal expenses
• Loss on deposits
• Repayments of Income
• Repayments of Social Security benefits
• Trustee administrative fees for an IRA
Deductions Not Subject to 2% limit – Schedule A, Line 27
• Gambling losses up to the amount of gambling winnings reported on Form 1040, line
21.
• Amortizable bond premiums (the amount paid is greater than its stated interest the
excess is the bond premium)
• Federal estate tax on income in respect of a decedent
• Unrecovered investment on annuity reported on final return of decedent
Nondeductible Expenses
• Brokers commissions
• Adoption expenses
• Campaign expenses
• Check-writing fees
• Club dues
• Commuting expenses
• Fines or penalties
• Health Spas
• Home security system
• Homeowners insurance premiums
• Investment related seminars
• Life insurance premiums
• Lobbying expenses
Phase out of Itemized Deductions

There is a limit on itemized deductions. For 2008 AGI threshold for itemized deduction phase
out is $159,950 ($79,975 for married filing separately).
140
The following itemized deductions are subject to the overall limit of itemized deductions:
• Taxes – Schedule A, Line 9
• Interest – Schedule A, Line 10, 11 and 12
• Gifts to Charity – Schedule A, Line 18
• Job expenses and most other miscellaneous deductions – Schedule A, Line 26
• Other miscellaneous deductions – Schedule A, Line 27 – excluding gambling and
casualty and theft
The following deductions are not subject to the overall limit:

• Medical and dental expenses – Schedule A, Line 4
• Investment interest expenses – Schedule A, Line 13
• Casualty and theft losses from personal use property – Schedule A, Line 19
• Casualty and theft losses from income-producing property – Schedule A, Line 27
• Gambling losses – Schedule A, Line 27
The total of all itemized deductions is reduced by the smaller of:

• 3% of the amount by which the AGI exceeds $159,950 ($79,750 if married filing
separately) for 2008.
• 80% of the itemized deductions that are affected by the limit.
• Schedule A lines 1 through 27 must be completed before computing the limit. All other
limits on Schedule A must be applied first. After the overall limit is applied the
amount should be compared to the standard deduction and the higher of the
standard deduction or the itemized deduction after the limitation is applied
should be used.
Standard Deduction
The basic standard deduction amounts for 2008 is:
• Head of household -$8,000
• Married taxpayers filing jointly and qualifying widow(er)s - $10,900
• Married taxpayers filing separately - $5,450
• Single - $5,450
The additional amount for over 65 and/or blind is $1,350 ($1,050 for married filing separate).
The standard deduction amount for an individual who may be claimed as a dependent by another
taxpayer may not exceed the greater of $900 for 2008 or the sum of $300 and the individual' s
earned income for 2008 not exceeding the standard deduction amount.
141
296. The phase out AGI threshold for itemized deductions for 2008 if married
filing joint is
A. $125,000
B. $159,950
C. $143,000
D. $150,000
297. Which medical and dental expenses qualify for itemized deductions?
A. The unreimbursed expenses that exceed 2% of AGI
B. The reimbursed expenses that exceed 5% of AGI
C. The unreimbursed expenses that exceed 7.5% of AGI
D. The unreimbursed expenses that exceed 10% of AGI
298. Medical and dental expenses include

A. Surgery to improve vision
B. Medical treatment for alcoholism
C. Lodging expenses while away from home to receive medical care in a hospital
D. All of the above
299. Which is not a medical expense?

A. Nursing help
B. Weight loss programs not prescribed by a doctor
C. Insurance premiums for medical and dental care
D. Acupuncturist expenses
300. Real estate taxes from state, local or foreign sources based on the assessed value of the
home are deductible
A. True
B. False
301. If a single taxpayer is a non-itemizer and pays real estate taxes, which one of the
following amounts can be added to the standard deduction?
A. $1,000
B. $450
C. $500
D. $2,000
302. Which of the following are not deductible as taxes on Schedule A

A. Foreign taxes
B. State Disability Insurance
C. Excise Taxes
D. State income taxes
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303. Which of the following is a true statement?
A. A taxpayer can claim some sales tax and some state and local income tax on Schedule
A.
B. SDI cannot be claimed as a deduction on Schedule A.
C. Personal property taxes based on the value of an asset are not deductible.
D. Individuals can deduct the larger of either the general sales tax or state and local
income tax.
304. Home mortgage interest is for any loan secured by

A. The main home and second home
B. The third home
C. The second and third home
305. A home must provide basic living accommodations including

A. Living space, cooking facilities, garage
B. Cooking facilities, garage, sleeping space
C. Garage, sleeping space, toilet
D. Sleeping space, toilet, cooking facilities
306. Limits apply to home mortgages taken out

A. After October 31st, 1987
B. After October 31st, 1988
C. After October 13th, 1987
D. After October 13th, 1988
307. Which of the following is not reported on Form 1098?

A. Home mortgage interest paid
B. Points paid on home acquisition
C. Interest income
D. Mortgage insurance premiums
308. Points charged when refinancing

A. Are deductible over the life of the loan
B. Are deductible (the remaining portion) when the mortgage is paid off
D. Neither A or B above
309. Investment interest includes interest allocable to self-employment income

A. True
B. False
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310. If a taxpayer drove to and from volunteer work
A. He may deduct 14 cents per mile
B. He may deduct parking and toll expenses
C. He may deduct actual cost of gas and oil instead 14 cents per mile
D. All of the above
311. Gifts of $250 or more are deductible

A. If the charitable organization issues a statement for the amount
B. To the extent of the donation
C. Each donation is treated separately
D. All of the above
312. Limits on charitable contributions for most common charitable organizations apply
A. When the contributions exceed 10% of AGI
B. When the contributions exceed 25% of AGI
C. When the contributions exceed 35% of AGI
D. When the contributions exceed 50% of AGI
313. The reduced limit for charitable contributions in the form of capital gain property donated
to an organization that is not listed as a 50% organization is
A. 15%
B. 20%
C. 25%
D. 35%
314. Charitable contributions exceeding the AGI limit must be carried over to
A. The next year
B. To each of the five subsequent years
C. The next three years
D. To each of the seven subsequent years
315. Carryovers of charitable contributions

A. Do not retain the original percentage limits
B. Are deducted before current year’s contributions
C. Retain the original percentage limits
316. Donations other than by check or cash

A. Are deducted at fair market value
B. Are deducted at the value a willing buyer would pay
C. Are deducted at the value a willing seller would sell
D. All of the above
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317. Appraisals on the value of the donation may be required if the total donation is over
A. $1,000
B. $2,500
C. $5,000
D. $7,500
318. Form 8283 is required if the deduction is more than

A. $500
B. $1,000
C. $3,000
D. $5,000
319. Non-business casualties or thefts are deductible if the total amount of all losses during he
year is more than
A. 2% of AGI
B. 5% of AGI
C. 10% of AGI
D. 12% of AGI
320. For non-business casualties or thefts to be deductible each separate casualty or theft must
exceed
A. $100
B. $250
C. $500
D. $1000
321. In 2008, the standard deduction can be increased by the excess of the taxpayer’s personal
casualty losses attributable to federal declared disaster over personal casualty gains.
A. True
B. False
322. Where can a tax preparer locate a list of Federally Declared Disaster Areas?
A. Federal Emergency Management Agency – FEMA.gov
B. IRS.gov
C. Publication 17
323. Job expenses and other miscellaneous deductions must exceed 2% of AGI
A. True
B. False
324. Ordinary and necessary expenses of an employee carrying on a trade or business include
A. Fees to employment agencies when looking for a new job
B. Dues to professional organizations
D. Neither A or B above
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325. Which is an ordinary and necessary expense of an employee carrying on a trade or
business?
A. Union Dues
B. Protective clothing
C. Tools used for work
D. All of the above
326. Receipts are required for employee business lodging expenses

A. Over $50
B. Over $75
C. Over $100
D. Any amount
327. If there is no accountable plan receipts for expenses other than lodging are generally
required for expenses
A. $50 or more
B. $75 or more
C. $100 or more
D. Any amount
328. The deduction for meals and entertainment is limited to

A. 80% of the amount that would otherwise be eligible
B. 75% of the amount that would otherwise be eligible
C. 50% of the amount that would otherwise be eligible
D. Deminimis fringe benefits are included in the limit
329. Taxes, tips, and parking are included in the deduction limit
A. True
B. False
330. Business gifts made in the course of a taxpayer’s trade or business are limited to
A. $50 to any one individual per year
B. $401 to any individual per year
C. $25 to any one individual per year
331. An award costing $400 or less given to an employee for length of service qualifies as a
deductible business gift
A. True
B. False
332. Items costing $4 or less are

A. Added until they reach the business gift limitation
B. Exceptions from the gift limitation
C. Considered to cost $5
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333. Travel away from home expenses are deductible at
A. 50%
B. 75%
C. 80%
D. 100%
334. Expenses for temporary employment are not deductible if

A. The employment exceeds six weeks
B. The employment exceeds four months
C. The employment exceeds six months
D. The employment exceeds one year
335. Excess reimbursement to an employee

A. Must be returned
B. Must be included in income
C. Is taxable after the $250
D. Is taxable after $500
336. Either the standard mileage rate or the actual expenses can be used to compute the
amount of automobile expenses
A. True
B. False
337. Which is not a record keeping requirement?

A. Total business miles driven in a year
B. The basis of the vehicle
C. Date placed in service
D. Annual finance charges
338. The standard mileage rate after June 30, 2008 is

A. 58.5 cents
B. 52.5 cents
C. 27 cents
D. 54.5 cents
339. Actual car expenses include the following

A. Depreciation
B. Garage rent
C. Gas
D. All of the above
340. Union dues are deductible on which form?

A. Schedule A, subject to 2% of the adjusted gross income.
B. Form 1040
C. Form 4562
D. Form 1116
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341. If a vehicle lease payment is for more than 30 days an inclusion amount is required.
A. True
B. False
342. Armed Forces reservists traveling more than 100 miles from home can deduct travel
expenses as an adjustment to income.
A. True
B. False
343. Work related education is deductible if

A. The education is required by the employer
B. The education maintains or improves skills needed in present work
C. The education is required by law
D. All of the above
344. Education needed to meet the education requirements of the taxpayer’s job is not
considered qualifying education.
A. True
B. False
345. Which of the following is not subject to the 2% AGI limitation?

A. Tax preparation fees
B. Hobby expenses
C. Life insurance premiums
D. Investment fees and expenses
346. Which of the following is subject to the 2% AGI limitation?

A. Adoption expenses
B. Legal expenses
C. Home security system
D. Investment related seminars
347. Phase out of itemized deductions is

A. AGI of more than $59,950 for MFJ for 2008
B. AGI of more than $79,975 for married filing separately for 2008
348. Which of the following itemized deductions are subject to the overall limit of itemized
deductions?
A. Interest
B. Taxes
C. Both A and B
D. Neither A or B
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349. Which of the following itemized deductions are not subject to the overall limit of
itemized deductions?
A. Job expenses
B. Interest
C. Casualties and theft losses
D. Taxes
350. Casualty and Theft is computed on which form?

A. Form 4684
B. Schedule C
C. Form 4562
D. Schedule B
351. For single filing status the additional amount for the blind is $1,350.
A. True
B. False
352. The extra amount for Age 65 or over is the same for MFS and MFJ
A. True
B. False
353. Employee business expenses are taken on Form _____________.

A. 4562
B. 8824
C. 2106
D. 4797
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Chapter 12 - Taxes and Credits
The income tax is based on taxable income. After the income tax is computed subtract any tax
credits and add any other taxes owed. The result is total tax. Compare the total tax with total
payments to determine whether the taxpayer is entitled to a refund or there is an amount owed.
Tax
Most taxpayers use either the tax table or the tax rate schedule to figure their
income tax. However there are special methods if the taxpayer has any of the
following items included in their return:
• Capital gains tax is computed on Schedule D, page 2 using the
following tax brackets according to the type of income.
Capital Gain Tax Rates

The following except is from Pub 17
• Qualified dividends taxed at capital gain rates - when there is a qualified dividend
the tax is computed on Schedule D, page 2. Qualified dividends differ from capital
gain distributions in as much as they do not net with capital gains and get included in
the total of Schedule D. Qualified dividends are included in income on Schedule B
and only affect the tax computation on Schedule D. See chart above
• Lump Sum Distributions-is a ten-year tax option used to compute the tax on the
ordinary income portion of the lump sum distribution. The tax is paid only once in the
year the lump-sum distribution is received. The special treatment can be elected only
once for any plan participant and only if the participant was born before January 2,
1936 (and beneficiaries of such individuals) (Refer to Form 4972 instructions)
• Farm income averaging - allows farmers to average their income over a three year
period (the tax is paid in the current year). (Refer to Schedule J Instructions)
• Investment income over $1,900 for children under 18 .
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“Kiddie Tax” - Tax on Investment Income of Certain Minor Children
(Form 8814 or Form 8615)
If a child’s interest, dividends and other investments total more than $1,800 part
of that income may be taxed at the parent’s tax rate instead of the child’s. If the
interest and dividend income totals less than $9,000 the child’s parent may be able to choose to
include that income on the parent’s return rather than file a return for the child. These rules apply
whether or not the child is a dependent.
Investment income is generally all income other than salaries, wages and other amounts received
as pay for work done. It includes taxable interest, dividends, capital gains, the taxable part of
social security and pension payments, certain distributions from trusts. Investment income
includes amounts produced by assets the child obtained with earned income.
Parent’s can elect to report the child’s income on their tax return if all of the following apply:
• The child was under age 18 on January 1, 2009, or is 19-23 and a full time student
• The child’s only income was from interest and dividends
• The child’s gross income was less than $9,000
• The child is required to file for the tax year
• There were no estimated tax payments for the child
• There was no federal income tax withheld for the child
The election to report the income on the parent’s return avoids the filing of a return for the child,
but the election can affect the parent’s return
• Tax rate may be higher
• The child does not get benefit of any of the following deductions:
o Higher standard deduction for a blind child
o The deduction for a penalty on early withdrawal of the child’s interest
o Itemized deductions
• Reduced deduction of credits
• Penalty for underpayment of estimated tax
The additional tax is computed on Form 8814 to figure the child’s interest and dividend income
on the tax return. Only the amount over $1,800 is added to the parent’s income. If there is more
than one child, compute Form 8814 for each child. The total amount of income computed on
Form 8814 is added to Line 21 of Form 1040. If the income includes capital gain distributions or
qualified dividends a special worksheet must be used to compute the tax.
The tax computed on Form 8814 is added to the tax computed on the taxpayer’s Form 1040. If
there is more than one Form 8814 add the total of the computed tax to the taxpayer’s Form 1040.
Part II of Form 8814 is used to figure the tax on the $1,800 of the child’s interest and dividends
that does not get included in income. The additional tax is the smaller of:
a. 10% X (the child’s gross income - minus - $900) or
b. $75.
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Tax for children under age 18 who have investment income of more than $1,800 is reported on
Form 8615. Part of a child’s investment income may be subject to tax at the parent’s rate if all of
the following are true:
1. The child’s investment income was more than $1,800.
2. The child is required to file a tax return for 2008.
3. The child was under age 18 at the end of the year.
The parent’s personal information and tax must be included on Form 8615. The parent’s name
and social security number is required.
Refer to Pub 929, Form 8814 and 8615 instructions.
Alternative Minimum Tax
Alternative Minimum Tax (AMT) exists to make sure that taxpayers with substantial
income are not able to avoid paying tax. The law limits the benefits a taxpayer can
receive from favorable treatment of certain items. The AMT uses a separate
accounting method with its own rules that govern the recognition and timing of
income and expenses. The taxpayer is liable for either AMT or regular tax,
whichever is more.
AMT may be due if the taxable income for regular tax purposes is over the exemption amount
for regular tax combined with certain adjustments and preferences. Exemption amounts for 2008:
• $46,200 for single or head of household
• $69,950 for married filing jointly or qualifying widow(er)
• $34,975 for married filing separately
The most common exemptions and preferences include the following items:
• Addition of personal exemptions
• Addition of standard deduction
• Addition of itemized deductions claimed for state and local income taxes, certain
interest, most miscellaneous deductions and part of medical expenses
• Subtraction of any refund of state and local taxes included in gross income
• Changes to accelerated depreciation of certain property
• Difference between gain or loss on the sale of property reported for regular tax
purposes and AMT purposes
• Addition of certain income from incentive stock options
• Change in certain passive activity loss deductions
• Addition of certain depletion that is more than the basis of the property
• Addition of part of the deduction for certain intangible drilling costs, and
• Addition of tax-exempt interest on certain private activity bonds
AMT is computed using Form 6251; refer to the form instructions for further information.
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Credits
After the income tax is determined, the tax credits are determined. There are two kinds of credit,
refundable and nonrefundable. The nonrefundable credits can reduce the tax to zero but any
excess is not refundable. The refundable credit is treated as payments and is refundable. The
refundable credits are added to withholding and estimate payments. If this total is more than the
total tax the excess is refunded to the taxpayer.
Adoption Expense Credit (Internal Revenue Code Section 23)

A tax credit of up to $11,650 for qualifying expense paid to adopt an eligible
child. A credit of up to $11,650 may be allowed for the adoptions of a child with
special needs even if there are no expenses.
For 2008, if the modified adjusted gross income is more than $174,730 the credit is reduced, if
the modified adjusted gross income is $214,730 or more the credit cannot be claimed.
For 2009, the adoption credit is $12,150; if the modified adjusted gross income is more than
$182,180 the credit is reduced, if the modified adjusted gross income is $222,180 or more the
credit cannot be claimed.
Qualifying adoption expenses are reasonable and necessary adoption costs, court costs, attorney
fees, traveling expenses while away from home and other expenses that are directly related to
and for the purpose of the legal adoptions of an eligible child.
Nonqualifying expenses:
• Any expenses that violates state or federal law
• The carrying out of a surrogate parenting arrangement
• The adoption of a spouse’s child
• Using funds paid from any state or Federal program
• Allowed as a deduction under any other federal income tax rule
• Paid or reimbursed by the employer or anyone else
Eligible Child means:

• Under 18 years old or
• Physically or mentally handicapped
A child with special needs means:
• He or she is a citizen or resident of the United States; and
• A state (including the District of Columbia) determines that the child cannot or
should not be returned to his or her parents’ home and probably will not be adopted
unless adoptive assistance is provided to the adoptive parents
The credit can generally be taken in any year prior to the adoption becoming final. Use Form
8893. (Refer to Form 8893 instructions and Pub 968). If the full amount of the credit cannot be
taken in the current year due to the tax liability, the credit can be carried forward five years.
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Child and Dependent Care Credit (IRC Section 21)
If the taxpayer pays someone to care for a dependent that is under the age of 13 or for the spouse
or dependent that is not able to care for him or herself, the taxpayer may be able to claim a credit.
The credit can be up to 35% of the expenses. The expenses must be so the taxpayer can work.
To claim the credit the taxpayer must meet all of the following tests;
1. The care must be for one or more qualified person who is identified on Form 2441.
2. The taxpayer and the spouse if married must maintain the home of the qualifier for the
credit.
3. The taxpayer and spouse if married must have earned income during the year.
4. The child and dependent care expenses must be so the taxpayer and spouse if married can
work or look for work.
5. The person paid to care for a dependent cannot be a dependent of the taxpayer and must
be 19 or older.
6. The filing status cannot be married filing separate.
7. The care provider must be identified with either a Social Security Number or a Federal
Identification Number.
8. Dependent care benefits paid by the employer must be excluded from expenses before
computing the credit.
The dollar limit on the amount of the work-related expenses allowed for the credit is $3,000 for
one qualifying person and $6,000 for two or more qualifying persons. The amount of the credit is
determined by multiplying the work-related expenses (after applying the earned income and
dollar limits) by a percentage.
The percentage depends on the adjusted gross income refer to Form 2441 instructions for the
percentage. The amount of credit that can be claimed is limited to the amount of the regular tax
(after reduction by any allowable foreign tax credit) that is multiplied by a percentage. This
credit is not refundable and does not allow a carry forward. Report the credit on Form 2441.
Child Tax Credit (IRC Section 24)
The maximum Child Tax Credit is $1,000 for each qualifying child. There is a
new form for 2008 Form 8901, Information on Qualifying Children Who Are
Not Dependents to give the IRS information on any qualifying child for the child tax
credit if the child is not a dependent.
The additional child tax credit is a credit that may be taken if the taxpayer is not able to claim the
full amount of the child tax credit. The child tax credit is limited to the tax liability; the
additional child tax credit (Form 8812) is a refundable credit.
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A qualifying child for child tax credit purposes is a child that must be all of the following:
1. Under age 17 at the end of the tax year.
2. A citizen or resident of the United States.
3. Claimed as the taxpayer’s dependent.
4. Must be one of the following relationships:
• Son
• Daughter
• Adopted child
• Stepchild
• Descendent of any of those listed above.
• Brother
• Sister
• Step brother or sister
• Any descendent of any of those listed above that the taxpayer cares for as their
own
• Eligible foster child
The maximum amount of credit for 2008 is $1,000. The credit is limited to tax liability and is
eliminated if the adjusted gross income is above $110,000 for taxpayers filing joint; $75,000 for
taxpayers filing single, head of household or qualifying widow(er); and $55,000 for married
filing separately. The adjusted gross income is the amount on line 35 of Form 1040, unless the
taxpayer worked in a foreign country, Puerto Rico or American Samoa.
To claim the credit the taxpayer can file either Form 1040 or 1040A and must provide the name
and social security number of the qualifying dependent. (Refer to Pub 972).
Additional Child Tax Credit

This credit is for certain individuals who get less than the full amount of Child Tax Credit. This
is a refundable credit that allows the credit whether or not there is any tax liability. Complete the
child tax credit before computing the additional child tax credit. (Refer to Form 8812)
Education Credits (IRC Section 25(A))
The following three criteria must be met to take either the HOPE credit or the Lifetime
Learning Credit:
i. The taxpayer pays the qualified education expenses for
higher education
ii. The tuition and related expenses are for an eligible student
iii. The eligible student is the taxpayer, the spouse or a dependent that the
taxpayer claims an exemption for on the return.
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Comparison of Education Credits
Hope Credit Lifetime Learning Credit
Up to $1,800 credit per eligible student Up to $2,000 credit per return
Available only until the first 2 years of Available for all years of postsecondary
postsecondary education is completed education and for courses to acquire or improve
job skills
Available only for 2 years per eligible student Available for an unlimited number of years
Student must be pursuing an undergraduate Student does not need to be pursuing a degree
degree or other recognized educational or other recognized educational credential
credential
Student must be enrolled at least half time Available for one or more courses
for at least one academic period beginning
after the first of the year
No felony drug conviction on student’s record Felony drug conviction rule does not apply
The taxpayer cannot claim an education credit for 2008 if any of the following apply:
• The filing status is married filing separately
• The taxpayer is a dependent on another return
• The modified adjusted gross income is $48,000 ($96,000 if married filing jointly)
• The taxpayer is a nonresident alien in the tax year
The education credits are computed on Form 8863, it is a nonrefundable credit and there is no
carry forward or carry back provision. The Hope and Lifetime Learning cannot both be claimed
for the same eligible student in the same year.
Foreign Tax Credit (IRC Section 901(a))

Generally any foreign income taxes paid or accrued are eligible for the Foreign Tax Credit,
unless the income has been excluded from income on Form 2555. The credit is limited to the tax
liability and multiplied by the following fraction:
Taxable income from sources outside the United States

Total taxable income from U.S. and foreign sources
The foreign tax credit is reported on Form 1116 (Refer to Pub 514 for more information).
Foreign taxes paid or accrued on dividends, interest or royalties less than $300 ($600 if married
filing jointly) can be reported directly on Form 1040. If Form 1116 is used in the return and the
full amount of the credit is not allowed due to the tax liability, the foreign tax credit can be
carried back 2 years and carried forward for 5 years.
Mortgage Interest Credit (IRC Section 25)

The mortgage interest credit is intended to help lower income individuals purchase a home. If the
taxpayer qualifies they can receive a credit for part of the interest they paid. The deductible
interest on Schedule A is reduced by the amount used to compute the credit. To qualify the
taxpayer must be issued a certificate by state or local government. The credit rate on the
certificate is multiplied by the interest allowed. If the credit rate is over 20%, the maximum
amount of the credit is $2,000.
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The credit is reported on Form 8396. If the credit is more than the tax liability, the excess can be
carried forward for three years. (Refer to Pub. 530).
Credit for Prior Year Minimum Tax

This credit occurs if the taxpayer paid Alternative Minimum Tax generated by “deferral items”
in the prior year. Adjustments required under AMT rules fall into two categories:
Deferral items are AMT adjustments that do not cause a permanent difference in taxable income
over time.
• Circulation costs
• Depreciation after 1986
• Disposition of property
• Electing large partnerships
• Estates and trusts
• Exercise of incentive stock options
• Income from installment sale
• Intangible drilling costs
• Long-term contract
• Loss limitations
• Mining cost
• Passive activities
• Research and experimental costs
Exclusion items are AMT adjustments that result in a permanent change in tax, such as itemized
deduction adjustments.
• Depletion
• Interest from private bond activity
• Investment interest expense
• Medical and dental expense
• Miscellaneous deductions
• Qualified small business stock
• Tax refund
• Taxes
The prior year minimum tax credit is reported on Form 8801 and can be carried forward
indefinitely. The taxpayer can take the credit against regular tax if they:
1. Paid alternative minimum tax in the prior year.
2. Had an unused prior year credit
Credit for Taxpayers who Purchase or Lease Hybrid Vehicles or Other

Alternative Motor Vehicles
The tax credit for hybrid vehicles, which was enacted by the Energy Policy
Act of 2005, may be as much as $3,400 for those who purchase the most fuel-
efficient passenger automobiles and light trucks.
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Hybrid vehicles have drive trains powered by both an internal combustion engine and a
rechargeable battery. Many currently available hybrid vehicles may qualify for the tax credit.
Since taxpayers may claim the full amount of the allowable credit only up to the end of the first
calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th
hybrid and/or advanced lean-burn technology motor vehicle, consumers seeking the credit may
want to buy early in the year.
The phaseout period for a manufacturer begins with the second calendar quarter after the
calendar quarter in which the manufacturer records its 60,000th sale. For the second and third
calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50
percent of the credit. For the fourth and fifth calendar quarters, taxpayers may claim 25 percent
of the credit. For quarters after that fifth quarter, taxpayers may not claim the credit.
Fuel cell vehicles are propelled by power derived from one or more cells that convert chemical
energy directly into electricity by combining oxygen with hydrogen fuel. For passenger
automobiles or light trucks, the maximum allowable credit is $12,000 but greater credits are
available for heavier vehicles.
Alternative fuel vehicles include those fueled by compressed natural gas, liquefied natural gas,
liquefied petroleum gas, hydrogen, and any liquid that is at least 85 percent methanol. The
maximum allowable credit for vehicles weighing 8,500 pounds or less is $4,000.
Hybrid heavy trucks: For qualifying hybrid motor vehicles weighing more than 8,500 pounds but
not more than 14,000 pounds, the maximum allowable credit is $3,000. For qualifying hybrid
motor vehicles weighing more than 14,000 pounds but not more than 26,000 pounds, the
maximum allowable credit is $6,000. For qualifying hybrid motor vehicles weighing more than
26,000, the maximum allowable credit is $12,000
Retirement Savings Contribution Credit (IRC Section 25B)

The taxpayer may be able to take a credit of up to $1,000 ($2,000 if married filing joint) if they
are eligible contributions to an employer sponsored retirement plans or an IRA. The credit is a
percentage of the retirement contribution with highest credit for the lowest income taxpayers.
Eligible contributions include contributions to:
• Traditional or Roth IRA’s

• Tax-exempt employee-funded pension plans (501)(c)(18)
• Elective deferrals 401(k), 403(b) annuities, nonqualified deferred compensation plans
• Elective deferrals to SIMPLE’s or SEP’s
• Voluntary after tax employee contribution to any qualified retirement plan, annuity or
IRA
The amount of the credit depends on the amount of the adjusted gross income, filing status and
eligible contributions. The credit is claimed on Form 8880. (Refer to Pub 590 for further
information). The credit cannot be taken if the following apply:
• The amount of the taxpayer’s adjusted gross income is more than $26,500 ($39,750
for head of household and $53,000 for married filing joint)
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• The taxpayer was not at least 18 by the end of the year.
• The taxpayer was claimed as a dependent on another return
• The taxpayer was a full-time student
General Business Credit is a credit made up of several separate business related credits. The
General Business Credit is calculated on Form 3800 and consists of carry forward from prior
years plus the total of current year business credits. All of the following are part of the General
Business Credit:
• Form 6478 - Credit for alcohol used as fuel
• Form 8847 - Credit for contributions to selected community development
corporations
• Form 8846 - Credit for employee social security and Medicare taxes paid on certain
employee tips
• Form 8882 - Credit for employer provided childcare facilities and services
• Form 6785 - Credit for increasing research activities
• Form 8881 - Credit for small employer pension startup costs
• Form 8826 - Disabled Access Credit
• Form 8844 - Empowerment zone and renewal community employment credit
• Form 8830 - Enhanced oil recovery credit (Form 8830)
• Form 8845 - Indian employment credit
• Form 3468 - Investment credit (energy, reforestation, rehabilitation credits)
• Form 8586 - Low-income housing credit
• Form 8884 - New York Liberty Zone business employee credit
• Form 8861 - Welfare-to-work credit
• Form 5884 - Work opportunity credit
To claim any of these credits start with the Form listed above and the instructions including the
qualifications and requirements. If the taxpayer is claiming more than one credit or carryover or
carry back use Form 3800. (Refer to the instructions for Form 3800 and Form 6251, discussed in
the next chapter of this text, for an overview of the credits refer to Pub 334).
Other Taxes
Self-Employment Tax is discussed in Chapter 4 of this text; refer to Schedule SE for additional
information. Additional tax on IRA’s, other qualified retirement plans, etc. is in Chapter 6 of this
text; refer to Form 5329 instructions for additional information.
Social Security and Medicare taxes on tips not reported to the employer are reported on Form
4137. If a taxpayer received $20 or more in cash or charge tips in a month from any one job and
did not report all of those tips to the employer, the taxpayer must report the social security and
Medicare taxes on the unreported tips as an additional tax on the return. Form 4137 is reported
on Form 1040 on Line 58.
If the taxpayer works for someone and expects to receive an earned income credit, the taxpayer
can choose to receive an advanced earned income credit payment. The taxpayer must give the
employer a W-5 form, Earned Income Credit Advance Payment Certificate and the employer
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will include part of the credit in the regular pay.
The taxpayer can get part of the earned income credit paid throughout the year if the following
requirements are met:
• The taxpayer must expect the earned income and the AGI is less than a certain
amount. Refer to Form W-5 for the amount each year
• The taxpayer must expect to have a qualifying child
• The taxpayer must expect to meet all the requirements of the earned income credit
The taxpayer may meet all the requirements above and still not qualify if their wages are not
subject to federal income tax, social security tax and Medicare tax withholding. If the taxpayer
has more than one employer the Form W-5 should only be given to one of the employers. If the
taxpayer is married, both the taxpayer and spouse can file Form W-5 with their employer.
Advanced earned income credits are limited to 60% of the maximum credit with one qualifying
child, and are shown on Form W-2, box 9 and reported in the Other Taxes section of Form 1040.
Refer to Pub 596 for more information and to the EIC section in the next chapter of this text.
Household Employment Tax: If the taxpayer pays someone to work in their home, the taxpayer
may be a household employer. If the employee is self-employed or under the control of a third
party, such as a placement agency, the taxpayer is not a household employer.
If the taxpayer qualifies as a household employer, they must apply for a employer identification
number (EIN) and determine whether employment taxes must be paid. Employment taxes
include Social Security and Medicare taxes, federal unemployment taxes and federal income tax
withholding. For more information refer to Pub 926 and Schedule H (Form 1040). The taxpayer
may also have to pay state unemployment tax. A list of state employment tax agencies, including
addresses and phone numbers are included in Pub 926.
Schedule R is a nonrefundable credit the elderly US citizen over the age of 65 or under the age
of 65 who is retired on total and permanent disability and received taxable disability payments.
The taxpayer must supply a physician statement. The income requirements for this form are very
low and it is only claimed by people with very little income.
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354. Which of the following is used to determine whether the taxpayer is entitled
to a refund or there is an amount owed?
A. Total tax less payments received
B. Wages received
C. Taxable income minus tax credits
355. Which of the following do taxpayers use to figure their income tax?
A. Tax Table Chart
B. Tax Rate Schedule
C. Either A or B
D. Neither A or B
356. The maximum tax rate for unrecaptured section 1250 property is which if the following?
A. 8 percent
B. 10 percent
C. 25 percent
D. 15 percent
357. Qualified dividends are included in income on Schedule B and only affect the tax
computation on Schedule D.
A. True
B. False
358. When the parent elects to include the child'

s income on their tax return, how could it
affect the parent'
s tax return?
A. The tax rate may be higher
B. Reduced deduction of credits
C. Penalty for underpayment of estimated tax
D. All of the above
359. Part of a child's investment income may be subject to tax at the parent' s rate if the child is
under the age of 18, required to file a tax return for 2008 and has investment income of:
A. $1,900
B. $1,499
C. $1,200
D. $150
360. Alternative Minimum Tax exists so that taxpayers with substantial income:
A. Can avoid paying tax
B. Are not able to avoid paying tax
C. Can receive favorable treatment on certain items
D. All of the above
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361. AMT uses a separate accounting method with its own rules that govern the recognition
and timing of income and expenses:
A. True
B. False
362. The taxpayer is liable for either AMT or regular tax, whichever:
A. The taxpayer chooses
B. Is less
C. Is more
363. The taxpayer may have to pay AMT if the taxable income for regular tax purposes is over
the exemption amount for regular tax combined with certain adjustments and preferences.
The most common adjustments and preferences include the following, except:
A. Addition of personal exemptions
B. Addition of certain income from incentive stock options
C. Addition of any refund of state and local taxes included in gross income
D. Addition of tax-exempt interest on certain private activity bonds
364. There are two kinds of credits:

A. Favorable and unfavorable
B. Refundable and nonrefundable
C. Fortunate and unfortunate
D. Useful and not useful
365. Nonrefundable credits can reduce the tax to zero and any excess is refundable.
A. True
B. False
366. The maximum tax credit that may be allowed for qualifying expense paid to adopt an
eligible child is:
A. $11,650
B. $16,010
C. $1,016
367. The following is a list of qualifying adoption expenses, except:

A. Reasonable and necessary
B. The adoption of a spouse' s child
C. Court costs
D. Attorney fees
368. In an adoption, which of the following is an eligible child?

A. Under 18 years old
B. Physically or mentally handicapped
C. Both A or B
D. Neither A or B
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369. A taxpayer pays someone to care for their spouse that is not able to care for him or
herself so that the taxpayer can work. What is the maximum credit for the expenses that can
be claimed?
A. 35%
B. 53%
C. 25%
D. 40%
370. In order to claim the Child and Dependent Care Credit, eight tests must be met. Which of
the answers below is not one of the eight tests?
A. The taxpayer and spouse, if married, must have earned income during the year
B. The person paid to care for a dependent cannot be a dependent of the taxpayer and
must be at least 19 years old
C. The care provider must have a valid drivers license
D. The filing status cannot be married filing separate
371. The dollar limit for qualified expenses for the Child and Dependent Care Credit is
A. $3,000 for one child and $6,000 2 or more children
B. $4,000 for one child or more
C. $2,500 for one child and $5,000 for more than one child
372. The Child and Dependent Care Credit is a nonrefundable credit.

A. True
B. False
373. Which of the following is a true statement regarding The Child Tax Credit?
A. The Child Tax Credit must be reduced by any advanced payments of Child Tax
Credit.
B. The Child Tax Credit is limited to the tax liability.
C. The maximum Child Tax Credit is $1,000.
D. All of the above
374. Which of the following is not a requirement for a qualifying child for child tax credit
purposes:
A. Under age 17 at the end of the tax year.
B. A citizen or resident of the United States.
C. Claimed as the taxpayer’s dependent.
D. The child must be in public school
375. Which if the following is true regarding the Additional Child Tax Credit:
A. This credit is for certain individuals who get less than the full amount of Child Tax
Credit.
B. This is a refundable credit that allows the credit whether or there is any tax liability.
C. Complete the child tax credit before computing the additional child tax credit.
D. All of the above
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376. Which of the following is not a criteria of the HOPE or Lifetime Learning Credit
A. The taxpayer pays the qualified education expenses for higher education
B. The tuition and related expenses are for anyone the taxpayer pays the tuition.
C. The eligible student is the taxpayer, the spouse or a dependent that the taxpayer
claims an exemption for on the return.
377. The taxpayer cannot claim an education credit for 2008 if any of the following apply,
except:
A. The filing status is married filing separately
B. The taxpayer is a dependent on another return.
C. The modified adjusted gross income is $25,000 ($50,000 if married filing jointly)
D. The taxpayer is a nonresident alien in the tax year.
378. Which of the following is a correct statement regarding the Foreign Tax Credit?
A. The credit equals the tax liability from sources outside the US divided by taxable
income from US sources and foreign sources.
B. The Foreign Tax Credit is computed on Form 2555
C. The Foreign Tax Credit can be carried back 5 years
D. The Foreign Tax Credit is a refundable credit
379. The foreign taxes paid or accrued on dividends, interest or royalties less than $300 ($600
if married filing jointly) can be reported directly on Form 1040. The filing of Form 1116 is
not required.
A. True
B. False
380. Which of the following is not true about the Mortgage Interest Credit?
A. The deductible interest on Schedule A is reduced by the amount used to compute the
credit.
B. To qualify the taxpayer must be issued a certificate by the IRS.
C. The credit rate on the certificate is multiplied by the interest allowed.
D. If the credit rate is over 20%, the maximum amount of the credit is $2,000.
381. The Mortgage Interest Credit is intended to help lower income individuals purchase a
home.
A. True
B. False
382. The credit for _____________________________occurs if the taxpayer paid Alternative

Minimum Tax generated by “deferral items” in the prior year.
A. Alternative Minimum Tax
B. Child Tax Credit
C. Prior Year Minimum Tax
D. Retirement Savers Credit
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383. Adjustments required under AMT rules fall into two categories
A. Deferral and exclusion Items
B. Deductions and credits
C. Adjustments and taxes
384. Which of the following are deferral items that AMT adjustments that do not cause a
permanent difference in taxable income over time?
A. Depreciation after 1986
B. Circulation costs
C. Disposition of property
D. All of the above
385. The tax credit for hybrid vehicles may be as much as $3,400 for those who purchase the
most fuel-efficient automobiles and light trucks
A. True.
B. False
386. The taxpayer may be able to take the Retirement Savings Contribution Credit if they are
eligible contributions to which of the following?
A. A traditional IRA or Roth IRA.
B. An employer sponsored retirement plan.
C. A money market savings account
D. Both A and B above
387. The Retirement Saving’s Contribution Credit cannot be taken in which of the following
instances:
A. The amount of the taxpayer’s adjusted gross income is more than $26,500 ($39,750
for head of household and $53,000 for married filing joint)
B. The taxpayer was not 18 years of age at the end of the year.
C. The taxpayer is claimed as a dependent on another return
D. The taxpayer is not a full-time student
388. Which of the following forms are not part of the General Business Credit?
A. Form 8846 – Credit for employee social security and Medicare taxes paid on certain
employees tips
B. Form 8882 – Credit for employer provided childcare facilities and services
C. Form 6785 – Credit for increasing research activities
D. Form 6251 - Alternative Minimum Tax Credit
389. Which of the following are reported on Form 4137?

A. Social Security and Medicare taxes on tips not reported to the employer
B. Wages earned as a waitress
C. Health insurance coverage paid by the employer
D. All of the above
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390. Which is a requirement of receiving the earned income credit paid throughout the year?
A. The taxpayer must expect to receive earned income throughout the year and the AGI is
less than a certain amount.
B. The taxpayer must expect to have a qualifying child.
C. The taxpayer must expect to meet all the requirements of the earned income credit.
391. The taxpayer must give the employer a W-5 form, Earned Income Credit Advance
Payment Certificate and the employer will include part of the credit in the regular pay.
A. True
B. False
392. If the taxpayer pays someone to work in their home, the taxpayer may be subject to
_______________.
A. Household Employment Tax.
B. Alternative Minimum Tax
C. Self-Employment Tax
D. “Kiddie” Tax
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Chapter 13 - Payments, Withholding and Earned Income Credit
Withholding
Generally an employer withholds taxes from an employee’s pay, tax may also be
withheld from certain other income, including pensions, bonuses, and
commissions and gambling winnings. In each case the amount withheld is paid
to the IRS in the taxpayer’s name.
If the tax is not paid through withholding or not enough tax is withheld, the
taxpayer may have to pay estimated tax. Self-employed persons generally must pay their taxes
through estimates. Income from interest and capital gains, rent and royalty also may be subject to
withholding. Estimated tax is also used to pay self-employment tax and alternative minimum
tax.
The amount of income tax the employer withholds from regular pay depends on two things:
1. The amount the taxpayer earns
2. The information that is reported to the employer on Form W-4
Form W-4 includes three items the employer will need to withhold tax.
1. Whether to withhold at the single rate or at the lower married rate.
2. How many withholding allowances to claim (each allowance reduces the amount
withheld)
3. Whether the taxpayer wants an additional amount withheld.
If the taxpayer’s income is low enough that they will not have to pay income tax they may be
exempt from withholding. Whenever the taxpayer starts a new job or changes jobs they must fill
out a new W-4 form. There are worksheets to help the taxpayer compute how many allowances
should be claimed.
Supplemental wages include bonuses, commissions, overtime pay and certain sick pay. The
employer should figure withholding on certain wages using the same method used for regular
wages. If these supplemental wages are identified separately the employer can withhold at a flat
rate of 27%. There are penalties for falsely reporting information on Form W-4.
Tips reported to the employer are included in income and are subject to withholding. The
employer should not withhold tax on allocated tips, only on the taxpayer’s pay and reported tips.
The employer must withhold on the value of fringe benefits included in income for the period the
benefits are paid.
Sick pay is a payment to replace the taxpayer’s wages while the taxpayer is temporarily absent
from work. Paid by the employer and is subject to withholding. If sick pay is paid by a third
party and the employer is party to it, such as an insurance company, the taxpayer should file
Form W-4S with the company paying the sick pay. W-4S is a Request for Federal Income Tax
Withholding from Sick Pay.
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Gambling winnings subject to withholding are reported on Form W-2G showing
the amount of winnings and the amount of withholding. Gambling winnings of
more that $5,000 from the following sources are subject to income tax withholding:
• Any sweepstakes, wagering pool or lottery
• Any other wager, if the proceeds are at least 300 times the amount of the bet
The taxpayer can choose to have voluntary withholding on unemployment compensation and
other federal payments such as social security income. The taxpayer can choose withholding of
7, 10, 15, and 27% of each payment withheld. (Refer to Pub 505 for additional information on
withholding and estimated tax).
Estimated Tax
Estimated tax is the method used to pay tax on income not subject to withholding. This includes
income from self-employment, interest dividends, alimony, rent, gains from the sale of assets,
prizes, awards and when withholding is not enough on salaries and pensions. If the taxpayer
under withholds or does not pay enough estimated payments, they may be subject to a penalty.
Estimated taxes are required if both the following apply:

• The taxpayer expects to owe at least $1,000 in tax after subtracting the withholding
and credits
• The taxpayer expects the withholding and credits to be less than the smaller of
• 90% of the tax to be shown on the next year’s tax return (66 2/3 % for farmers and
fishermen)
• 100% of the taxes shown on the current year tax return
Estimated tax payments are not required if the taxpayer meets all of the following requirements:
• There was no tax liability for the prior year
• The taxpayer was a U.S. resident for the whole year
• The prior year return covered a full 12 months
Compute the estimated tax for the next year by starting with the current year income, deductions
and credits, and use the ES worksheet. Make adjustments for changing situations. Standard due
dates for estimated tax payments are Apr. 15, June 15, Sept 15 and Jan 15 of the next year.
There are five ways to pay estimated tax:

1. Credit the overpayment on the current year return to the next year.
2. Send a payment with the payment voucher from Form 1040-ES
3. Use the Electronic Federal Tax Payment System (EFTPS)
4. Electronic funds withdrawal
5. Credit card using pay by phone system or the Internet
Earned Income Credit
The earned income credit is a tax credit for certain people who work and have
income under a certain amount. Everyone must meet all the following seven
rules to qualify.
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Rules everyone must follow for EIC:
1. The 2008 AGI must be less than
• $43,415 ($40,295 for married filing jointly) if the taxpayer has more than one
qualifying child
• $38,583 ($35,463 for married filing jointly) if the taxpayer has one qualifying child
• $16,560 ($13,440 for married filing jointly) if the taxpayer has no qualifying child
2. The taxpayer, spouse and qualifying child must all have valid Social Security Numbers.
3. Filing status cannot be married filing separately
4. The taxpayer must be a U.S. citizen or resident alien for the entire year.
5. The taxpayer cannot claim the earned income credit if they file Form 2555 to exclude
foreign income.
6. The earned income credit cannot be claimed unless the taxpayer’s investment income is
$3,100 or less. For most people investment income is the total of the following:
• Taxable interest
• Tax-exempt interest
• Taxable dividend
• Capital gain net income
7. The taxpayer must have earned income. Earned income includes:
• Wages, salaries and tips
• Net earnings from self-employment
• Gross income from a statutory employee
Rules if the taxpayer has a qualifying child:
8. The child must meet the age, relationship and residency tests
Relationship test
• Son
• Daughter
• Adopted child
• Stepchild
• Descendent of any of those listed above.
• Brother
• Sister
• Step brother
• Step sister
• Any descendent of any of those listed above that the taxpayer cares for as their own
• Eligible foster child
Age Test – the child must be either under the age of 19 at the end of the year; a full-time
student under the age of 24 at the end of the year or; permanently and totally disabled at any
time during the year, regardless of age.
Residency Test – the child must have lived with the taxpayer in the United States for more
than half of the year.
9. The qualifying child cannot be used by more than one person to claim the EIC. If more
than one person claims the EIC using the same child then only the parent can treat the
child as a qualifying child. If the two persons are both parents then the parent with whom
the child lived the longest can treat the child as a qualifying child. If the child lived with
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both parents the same then the parent with the highest adjusted gross income can treat the
child as a qualifying child. If neither of the person’s are a parent then the person with the
highest AGI can treat the child as the qualifying child.
10. The taxpayer cannot be a qualifying child of another person – this applies to the taxpayer
and the spouse.
Rules if the taxpayer does not have a qualifying child:
11. The taxpayer must be at least 25 but under age 65 at the end of the year. If married filing
a joint return, either the taxpayer or the spouse must be at least 25 but under 65 at the end
of the year. It does not matter which spouse meets the age test, as long as one does.
12. The taxpayer cannot be a dependent of another person, this applies to the taxpayer and
the spouse if married filing joint.
13. The taxpayer cannot be a qualifying child of another person
14. The home of the taxpayer and spouse (if married filing joint) must have been in the
United States for more than half of the year.
Figuring and claiming the Earned Income Credit:
15. The earned income must be less than the AGI amounts listed in #1.
Earned income generally means wages, salaries, tips, other taxable employee compensation and
net earnings from self-employment. To figure the amount of the earned income credit use the
EIC worksheet found in the instruction booklet for Form 1040, 1040A or 1040EZ. Taxpayers
who fraudulently claim Earned Income Credit are disqualified from taking it the credit for the
next ten years. Taxpayers who improperly claim the EIC with a reckless disregard of the rules
are disqualified for the next two years. Taxpayers must file Form 8862 to be reinstated for
eligibility in the future.
EITC Due Diligence
A $100 penalty is imposed on a preparer who fails to meet due diligence requirements with
respect to EIC. IRS notice 97-65 contains the procedures the preparer must follow to protect
themselves from the penalty:
1. The preparer must complete Form 8867 (or similar form that provides the same
information) or the EIC eligibility checklist contained in Notice 97-65
2. The preparer must complete the EIC worksheet in Form 1040 instructions.
3. The preparer must make reasonable inquiries if the information furnished to the preparer
appears to be incorrect.
4. The preparer must retain the above information, including a record of how and when the
information was obtained and the identity of the person furnishing the information for
three years after June 30th following the date the return was presented to the taxpayer for
signature.
Excess Social Security and Tier 1 RRTA Withheld

The maximum amount of social security tax withheld (FICA) for 2008 is $6,324. If the
taxpayer’s employer withheld in excess of this amount the taxpayer should ask the employer to
refund the excess. If the taxpayer has more than one employer the excess withheld can be
claimed on the return. Figure the taxpayer and spouse separately.
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393. Withholding is always paid to the IRS in the taxpayer’s name.
A. True
B. False
394. Which of the following is generally an item on which the employer would withhold taxes
from an employee’s pay?
A. Wages
B. Bonuses
C. Commissions
D. All of the above
395. The amount of income tax the employer withholds from regular pay depends on which of
the following?
A. The amount the taxpayer earns
B. The information that is reported to the employer on Form W-4
C. Both A and B
D. Neither A or B
396. Which of the following items are usually included when computing estimated tax
vouchers?
A. Alternative minimum tax
B. Self-employed income.
C. Income from interest and capital gains
D. All of the above
397. Form W-4 includes which items the employer will need to withhold tax.
A. Whether to withhold at the single rate or at the lower married rate.
B. How many withholding allowances to claim
C. Whether the taxpayer wants an additional amount withheld.
D. All of the above
398. Which of the following is true about withholding and Form W-4?
A. If the taxpayer’s income is low enough that they will not have to pay income tax they
may be exempt from withholding.
B. Whenever the taxpayer starts a new job or changes jobs they must fill out a new W-4
form.
C. There are worksheets to help the taxpayer compute how many allowances should be
claimed.
D. All of the above
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399. The following statements are true regarding withholding, except:
A. Supplemental wages are identified separately the employer can withhold at a flat rate of
27%.
B. Tips reported to the employer are included in income and are subject to withholding.
C. The employer must withhold on the value of fringe benefits included in income for the
period the benefits are paid.
D. There are no penalties associated with the W-4
400. Gambling winnings of more than $5,000 from a wagers sweepstakes or lottery, if the
proceeds are at least 300 times the amount of the bet, are subject to withholding and are
reported on Form W-2G showing the amount of winnings and the amount of withholding.
A. True
B. False
401. Estimated tax payments are not required if the taxpayer meets all of the following
requirements, except:
A. There was no tax liability for the prior year
B. The taxpayer was a U.S. resident for the whole year
C. If there are wages subject to withholding
D. The prior year return covered a full 12 months.
402. Which of the following is an acceptable way to pay estimated tax?

A. Credit the overpayment on the current year return to the next year.
B. Send a payment with the payment voucher from Form 1040-ES
C. Use the Electronic Federal Tax Payment System (EFTPS)
D. Credit card using pay by phone system or the Internet
E. All of the above
403. The earned income credit is a tax credit for certain people who work and have income
under a certain amount.
A. True
B. False
404. Rules everyone must follow for EIC, include the following, except:
A. The taxpayer, spouse and qualifying child must all have valid Social Security Numbers.
B. Filing status cannot be married filing separately
C. The taxpayer must be a U.S. citizen or resident alien for the entire year.
D. The taxpayer cannot claim the earned income credit if they file Form 2555 to exclude
foreign income.
E. The earned income credit cannot be claimed unless the taxpayer’s investment income is
$5,000 or less.
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405. The following rules apply for the EIC if the taxpayer has a qualifying child, except:
A. To meet the relationship test the child can be a friend’s child living in the household.
B. Age Test – the child must be either under the age of 19 at the end of the year; a full-time
student under the age of 24 at the end of the year or; permanently and totally disabled at
any time during the year, regardless of age.
C. Residency Test – the child must have lived with the taxpayer in the United States for
more than half of the year.
406. If the taxpayer does not have a qualifying child for EIC purpose all the following rules
are correct, except :
A. The taxpayer must be at least 25 but under age 65 at the end of the year. If married filing
a joint return, either the taxpayer or the spouse must be at least 25 but under 65 at the end
of the year. It does not matter which spouse meets the age test, as long as on does.
B. The taxpayer cannot be a dependent of another person, this applies to the taxpayer and
the spouse if married filing joint.
C. The taxpayer cannot be a qualifying child of another person
D. The home of the taxpayer and spouse (if married filing joint) must have been in the
United States for at least three months of the year.
407. Earned income generally means wages, salaries, tips, other taxable employee
compensation and net earnings from self-employment.
A. True
B. False
408. Special penalties apply to fraudulently claiming Earned Income Credit, which of the
following are true
A. Taxpayers who fraudulently claim Earned Income Credit are disqualified from taking the
credit for the next ten years.
B. Taxpayers who improperly claim the EIC with a reckless disregard of the rules are
disqualified for the next two years.
C. Taxpayers must file Form 8862 to be reinstated for eligibility in the future
D. All of the above
E. None of the above
409. EITC due diligence are preparer requirements with respect to EIC.
A. True
B. False
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410. The preparer must follow the following rules to protect themselves from the penalty. All
the following are true except:
A. The preparer must complete Form 8867 or the EIC eligibility checklist contained in
Notice 97-65
B. The preparer must complete the EIC worksheet in Form 1040 instructions.
C. The preparer must make reasonable inquiries if the information furnished to the preparer
appears to be incorrect.
D. The preparer must retain the above information, including a record of how and when the
information was obtained and the identity of the person furnishing the information for ten
years after June 30th following the date the return was presented to the taxpayer for
signature.
411. Which of the following is true regarding Social Security Tax Withheld?
A. The maximum amount of social security tax withheld from one employer for 2008 is
$6,324.
B. Excess Social Security Tax Withheld by one employer must be entered on Form 1040 for
a refund.
C. The tax payer and spouse maximum social security tax is computed together.
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Chapter 14 – Refunds, Amount Due & Electronic Filing
Refund
If there is withholding, estimated tax or a refundable credit in excess of the total tax liability,
there is an overpayment which can be refunded, unless there is unpaid child or spousal support,
other federal debts or state tax judgment.
The taxpayer can elect to have the refund directly deposited to either a savings or checking
account in the taxpayer’s name. A bank account number and the routing number of the bank are
required for direct deposit. The routing number should either be furnished by the bank or taken
directly from a check.
The amount of refund can also be applied to the next year’s tax. To check the status of a refund
go the IRS website; click on the link “Where is my Refund?” Enter the taxpayer SSN, filing
status, and refund amount.
Amount Owed
If the withholding or estimated tax payments were not enough to cover the tax liability there is
an amount owed. Payments can be made in several ways:
• If payment is by check, make the check payable to the United States Treasury; write
the SSN on the check and “2008 Form 1040”. Complete the payment voucher “1040-
V” and send that with the check loose on top of the return
• Credit Card payments can be made through service providers. The IRS accepts
American Express, Master Card, Discover and Visa. The taxpayer will be charged a
convenience fee
• The taxpayer can also make a direct deposit through their financial institution. The
taxpayer will have to register first by going to www.eftps.gov
Underpayment of Estimated Tax Penalty (Form 2210) the penalty does not apply if:
• The tax due after subtracting withholding is less than $1,000
• The taxpayer was a U.S. citizen and had no tax liability on a 2008 return that was for
a 12 month period
Required annual payment – for the tax year 2008, individuals are subject to an underpayment
penalty unless total withholding and estimated payments equal the smaller of:
• 90% of the tax shown on the return
• 100% of the tax shown on the 2008 return (110% if the taxpayer’s 2008 AGI was
over $150,000/$75,000 MFS)
• The required annual payment must be paid in four equal installments. If any
installment is paid late, the penalty is charged to that quarter
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Returns must contain signatures to be considered filed in a timely manner. If the
filing status is married filing joint, both spouses must sign the return. If the
taxpayer is a minor child and cannot sign, the parent can sign the return for the
children. Write next to the signature “By parent of minor child”.
If the return was prepared by a paid preparer, the paid preparer box must be signed and a social
security number or PTIN (Personal Tax Identification Number) must be furnished. (Refer to
Form 1040 instructions for further information).
Electronic Filing - Federal and California

A qualified tax practitioner can electronically transmit tax returns to the IRS by applying to
become an authorized e-file provider. California allows electronically filed tax returns to be
transmitted simultaneously with the federal. States that allow the merging of the returns are
called “piggy back” states.
California law now mandates tax practitioner who prepare 100 or more tax returns in the prior
tax year to e-file their clients’ individual income tax returns.
Form 8633 is used for a practitioner to apply for IRS acceptance as an authorized provider. A
separate application is required for each business location originating e-file returns. Authorized
electronic filing providers include the following:
1. Electronic return originator- most tax preparer’s who offer electronic filing
are ERO’s. Commonly, the ERO completes the client’s tax return and then
transmits the data to the software provider. The software provider then
transmits the return to the IRS. The practitioner can also transmit directly to
the IRS.
2. Reporting agents are accounting services, franchisers, banks or others
authorized to electronically prepare a Form 940 or Form 941 for a taxpayer.
3. Transmitters send electronic data directly to the IRS.
4. Online providers – transmit tax return information prepared by a taxpayer
using purchased commercial software.
5. Software developers – create software to format electronic tax return
information.
6. Intermediate service providers take tax return information from an ERO,
and either forward the information to a transmitter or send the return back to
the ERO.
Each tax practitioner must go through a finger printing process and a suitability check. A
finger print card must be submitted with Form 8633 for each responsible official, corporate
officer, owner or partner listed on the application. Once accepted into the program, the provider
is assigned an Electronic Filing Identification Number (EFIN). After the EFIN is obtained from
the IRS the practitioner must file FTB Form 8633 with the California Franchise Tax Board. Once
the form is received by the FTB they will ensure that all business entities are valid and licensed,
and all personal and business tax returns are filed timely, and all liabilities are current. They will
then issue an acceptance letter; at that point the practitioner’s EFIN is valid for both Federal and
state
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All California individual tax returns must be electronically filed unless the return does not
qualify for electronic filing or the taxpayer does not want to electronically file. If the taxpayer
chooses not to e-file Form 8454 e-file Opt-Out Record must be retained in the practitioner’s
office.
Federal and California returns not eligible for electronic filing are as follows:
• Returns other than current year returns
• Fiscal year returns
• Amended Returns
• Married filing separate returns in community property states (AZ, CA, ID, LA, NV,
NM, TX, WA, WI) (Eligible for CA electronic filing)
• Most returns with TINs of 900-00-0000 and up. Exceptions may apply to ATINs and
ITINs
• CA returns with dollars and cents
Electronic filing software used by an ERO converts tax information into electronic data suitable
for transmission via modem. Most software will validate the return after it is prepared and will
prompt the preparer to correct the errors or omissions that cause the reject. Most software will
not allow transmission of the return to the IRS until the errors are corrected.
The IRS and the FTB will notify the transmitter whether a return was accepted or rejected within
48 hours of transmission. If the return is rejected by the IRS after the validation by the tax
software the IRS or the FTB will send an explanation with an error reject code. A common
reject that will occur after validation by the tax software is a wrong social security number of the
taxpayer, spouse or dependent. The IRS compares all social security numbers to the Social
Security Administration lists. A rejected return may be corrected and resubmitted to the IRS.
The taxpayer must execute a paper or electronic signature on every return submitted for
electronic filing. If the taxpayer executed a signature and the return needs a correction, the
taxpayer must generally sign the corrected return before resubmission. The electronic return data
may be corrected without obtaining a new signature from the taxpayer if the changes are not
more than $50 to total income and $14 to total tax, federal tax withheld, refund or amount owed.
An ERO is required to retain certain material until the end of the calendar year in which a return
is filed:
• A signed copy of Form 8453 for paper signatures or FTB
• A signed copy of e-file consent to disclosure forms for taxpayers who provide
electronic signature
• Paper copies of W-2, W-2G and 1099-R as well as any supporting documents
• A complete copy of electronic portion of the return (which may be retained in
magnetic media)
• The acknowledgement file received from the IRS, FTB or a third party transmitter
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Taxpayers have the option of receiving a refund from the IRS or FTB in the form of a paper
check or direct deposit to a qualified account in the taxpayer’s name. Taxpayer’s who choose
direct deposit must provide the ERO with account and routing numbers of the taxpayer’s
financial institution. Financial institutions do not allow the deposit of joint refunds in an
individual account. The account number and routing number are transmitted along with the e-file
return. If there is an amount due the taxpayer may indicate the date (prior to April 15th) to
withdraw the funds. If the taxpayer is mailing payment Form 1040V (Payment Voucher) or FTB
Form 3582 (Payment Voucher for Electronically Transmitted Returns) must accompany the
payment. An ERO cannot charge a separate fee for direct deposit.
Tax Return Assembly

Federal returns that are not electronically filed must be assembled behind Form
1040 in the order of the “Attachment Sequence No.” shown in the upper right
corner of the schedule. If there are supporting schedules or forms arrange them in the
same sequence as the forms and attach them last. Correspondence should not be
attached unless requested. Attach a copy of Forms W-2, W-2G and 2439 to the front of Form
1040; also attach Form 1099-R if tax was withheld.
California returns that are not electronically filed and not prepared by a paid preparer, attach a
copy of Forms W-2 and W-2G to the front of Form 540; also attach Form 1099-R if state tax was
withheld, assemble all California supporting schedules behind Form 540, then a copy of the
federal return (if required – see below) and then a copy of any other state return that may be
required. If the return is prepared by a paid preparer using approved software, with bar codes, do
not staple Form 540 page 1 and 2. If W-2’s need to be attached, attach them to Schedule W-2
behind page 2 of the tax return and in front of Schedule CA and assemble the return as noted
above, attaching the supporting California documents and Federal return behind Schedule W-2.
Put Form 5805 at the back.
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412. If there is withholding, estimated tax or a refundable credit in excess of
the total tax liability, there is a ________________ which can be refunded,
unless there is unpaid child or spousal support, other federal debts or state
tax judgment.
A. Refund
B. Withholding
C. Overpayment
D. Tax
413. A bank account number and the routing number of the bank are required for direct
deposit.
A. True
B. False
414. If the withholding or estimated tax payments were not enough to cover the tax liability
there is an amount owed. Which is not an acceptable way of making payments of tax owed?
A. If payment is by check, make the check payable to the United States Treasury; write the
SSN on the check and “2008 Form 1040”. Complete the payment voucher “1040-V” and
send that with the check loose on top of the return.
B. Credit Card payments can be made through service providers. The IRS accepts American
Express, Master Card, Discover and Visa. The taxpayer will be charged a convenience
fee.
C. The taxpayer can also make a direct deposit through their financial institution. The
taxpayer will have to register first by going to www.eftps.gov.
D. The taxpayer can attach a letter and make bi-monthly payments.
415. To avoid an underpayment penalty (Form 2210) the taxpayer is required to pay in
withholding and estimates at least $1,000.
A. True
B. False
416. Returns must contain signatures to be considered filed in a timely manner. Which of the
following is not an acceptable signature?
A. If the filing status is married filing joint, both spouses must sign the return.
B. If the taxpayer is a minor child and cannot sign, the parent can sign the return for the
children. Write next to the signature “By parent of minor child”.
C. Head of household filer must have the signature of the qualifier
D. Married filing a separate return, the taxpayer signs the return.
417. If the return was prepared by a paid preparer, the paid preparer box must be signed and a
social security number or PTIN (Personal Tax Identification Number) must be furnished.
A. True
B. False
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418. Which of the following is true regarding Electronic Filing?
A. A qualified tax practitioner can electronically transmit tax returns to the IRS by applying
to become an authorized e-file provider.
B. California allows electronically filed tax returns to be transmitted simultaneously with the
federal.
C. States that allow the merging of the returns for electronic filing purposes are called
“piggy back” states.
D. California law now mandates tax practitioner who prepare 100 or more tax returns in the
prior tax year to e-file their clients’ individual income tax returns.
E. All of the above
419. Which Form is filed with the IRS to receive an Electronic Filing Identification Number
(EFIN)?
A. Form 8633
B. Form 6453
C. Form 8879
420. Commonly, the ___________________ completes the client’s tax return and then
transmits the data to the software provider
A. ERO – Electronic Return Originator.
B. Transmitters Online providers
C. Software developers –
D. Intermediate service providers.
421. Which of the following are true statements regarding preparers in CA who are required to
electronically file?
A. Each tax practitioner must go through a finger printing process and a suitability check
B. Once accepted into the program, the provider is assigned an Electronic Filing
Identification Number (EFIN).
C. After the EFIN is obtained from the IRS the practitioner must file FTB Form 8633 with
the California Franchise Tax Board
D. All California individual tax returns must be electronically filed unless the preparer opts-
out.
422. All the following Federal and California returns are eligible for electronic filing:
A. Returns other than current year returns.
B. Fiscal year returns
C. Amended Returns
E. All of the above
423. Electronic filing software used by an ERO converts tax information into electronic data
suitable for transmission.
A. True
B. False.
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Chapter 15 – Various Taxes
Gift and Estate Tax
A gift tax is a tax on transfers made without adequate payment during life. An
estate tax is a tax on transfers of property after death. One set of rates apply to
both gift and estate tax. The tax is generally imposed on the person
transferring rather than the recipient.
Every taxpayer is allowed exemptions from gift and estate tax before the tax is imposed.
The estate tax exemption is $2 million for decedents dying in 2006 - 2008. Estate tax is repealed
in 2010, gift tax is not repealed.
A gift tax return is filed on Form 709 if the taxpayer makes any gifts over $12,000 to someone
other than a spouse or charity. The gift tax exclusion is $1 million and is not indexed for
inflation., A gift tax is calculated on the cumulative total of all gifts given in all prior years, the
tax due is the difference between the tax on the cumulative total and the tax on gifts made in
prior years, less any remaining exemption. The annual exclusion of $12,000 is indexed for
inflation and will change again when cost of living adjustments reach the next $1,000 multiple.
An estate tax return must be filed if the decedent’s gross estate at death plus taxable lifetime gifts
exceed $2 million amount for 2008. The estate return is filed on Form 706. The gross estate
includes all property owned by a decedent at the time of death. The estate can deduct funeral
expenses, administrative expenses, claims paid, including debts and losses. The estate can also
deduct property passing to qualified charities and to a surviving spouse.
All taxable gifts made by a decedent during life are added to the gross estate. The estate received
credit for gift tax paid by the decedent.
Excise Tax
Excise taxes are taxes paid when purchases are made on a specific good, such as
gasoline. Excise taxes are often included in the price of the product. There are also
excise taxes on activities such as on wagering or on highway usage by trucks.
Excise tax has several general excise programs. One of the major components of
the excise program is motor fuels.
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Federal and State Unemployment Tax (FUTA and SUI)
The employer must pay a percentage of the first $7,000 of wages paid to each employee in a
calendar year as FUTA tax and state unemployment insurance (UI). The Federal Unemployment
Tax Act along with state unemployment compensation provides for payments of unemployment
compensation to workers who have lost their job.
FUTA tax is paid at 6.2% of the first $7,000. The state rate may be different. Generally there is a
credit against FUTA tax for the amounts paid to state unemployment tax. The credit cannot be
more than 5.4% of taxable wages. If the maximum is paid, then the FUTA tax rate will be 0.8%.
Sales Tax is charged on tangible personal property sold in California (and many other states).
Tangible personal property includes include furniture, toys clothing, etc. The sales tax is
collected by the retailer and paid to the state. There is no national sales tax. Purchases made from
an out-of-state source or the Internet is also subject to tax. Use tax is charged on these items. Use
tax and sales tax rates are the same.
182
424. A gift tax is a tax on transfers made without adequate payment during life
A. True
B. False
425. A gift tax return is filed on which of the following forms?

A. Form 709
B. Form 706
C. Form 1041
426. Which of the following is true about gift and estate taxes?
A. One set of rates apply to both the gift tax return and estate tax
B. No tax will be due on a gift until the $1 million exemption is exhausted
C. The gross estate includes all property owned by the decedent at the time of death
D. All of the above
427. Which of the following is not true regarding excise taxes?

A. Excise taxes are paid when purchases are made on a specific good
B. Excise taxes are often included in the price of the product
C. Excise tax is included in the price of gasoline
D. Excise tax is included on Form 1040.
428. The following are true about the State Unemployment Insurance (SUI) along with the
Federal Unemployment Tax Act (FUTA), except:
A. The employer must pay a percentage of the first $7,000 of wages paid to each employee
in a calendar year as FUTA tax and state unemployment insurance (UI).
B. The Federal Unemployment Tax Act along with states unemployment compensation
provides for payments of unemployment compensation to workers who have lost there
job.
C. FUTA tax is paid at 6.2% of the first $7,000. The state rate may be different.
D. All of the above
429. Which of the following is true about Sales tax?

A. Sales tax is charged on personal property sold in California and many other states
B. The sales tax is collect by the retailer and paid to the state
C. There is no national sales tax
D. Use tax and sales tax rates are the same
E. All of the above
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Chapter 16 –The Basic California Return
Electronic filing has become mandatory in California. If a tax practitioner

prepared more than 100 individual tax returns during the calendar year that began
January 1, 2003 and in the current year they prepare one or more individual tax
returns using tax preparation software, then for that calendar year and all
subsequent calendar years thereafter all income tax returns shall be electronically
filed with the Franchise Tax Board. (Refer to Chapter 13 in this text or FTB Pub 1345
and 1345A for additional information)
Who Must File a California Tax Return?

The federal tax returns (Form 1040, 1040a or 1040EZ) must be complete before beginning the
California return. California tax returns start with federal adjusted gross income and primarily
Schedule CA is used to make adjustments where the California law does not conform. California
is commonly known as an AGI state.
Even if there is no filing requirement according to the chart below, if there was California
withholding or estimated tax payments the taxpayer should file for a refund. The taxpayer must
file a return if either the California gross income or the California AGI is more than the amount
shown for the taxpayers filing status, age and number of dependents.
California Gross Income California AGI

Filing status
Age at 12/31/07 Dependents Dependents
12/31/07
0 1 2 or more 0 1 2 or more
Single or Under 65 14,845 25,145 32,870 11,876 22,176 29,901
Head of Household 65 or older 19,795 26,188 33,700 16,826 24,551 30,731
Under 65 (both
spouses) 29,690 39,990 47,715 23,752 32,052 41,777
Married 65 or older (1 sp) 34,640 42,365 48,545 28,702 36,427 42,607
65 or older (both 39,590 47,315 53,495 33,652 41,377 47,557
spouses)
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Exemptions - 2008
Personal Exemptions - $99 – if married filing joint each spouse receives an exemption
Blind Exemption -$99 – Visually impaired taxpayer or spouse.
Senior Exemption - $99 – 65 or older taxpayer or spouse.
Dependent exemption - $309 per dependent
California Standard Deductions
Filing Status CA Standard Deduction
2007 2008
Single $3,516 $3,692
Married Filing Joint 7,032 3,692
Married Filing Separate 3,410 7,384
Head of Household 7,032 7,384
Qualifying Widow(er) 7,032 7,384
Frequently, a taxpayer can itemize on the federal or CA returns and takes the standard deduction
on the other. CA does not allow an addition to the standard deduction for taxpayers who are 65
or blind. Instead, they get an additional exemption.
Itemized deductions for California are subject to adjusted gross income limitations similar to
the federal itemized deduction AGI limitation Itemized Deductions must be reduced by the lesser
of 6% of the excess of the taxpayer’s federal AGI over the threshold amount or 80% of the
amount of itemized deductions otherwise allowed for the taxable year. Threshold amount:
Single/ married filing separately/ RDP $163,187
Married filing joint or qualifying widow(er) $326,379
Head of Household $244,785
California makes an adjustment for State and local taxes deducted on the federal return. Also
adjustments for law difference such as Section 179 over the CA limit of $25,000 for an employee
business expense; or meals provided for the convenience of the employer the federal allows over
the 50% CA did not conform.
The taxpayer must use the same filing status on California as they did on the federal return,
except married taxpayers who file a joint return may file either separate if either spouse is active
military or California nonresident with no California source income.
Requirements for head of household filing status:

• The taxpayer was unmarried or considered unmarried on the last day of the taxable
year
• The taxpayer paid more than one-half the cost of keeping up the home
• For more than half the year (over 6 months, over 183 days) the home was the main
home for the taxpayer and another person who lived with the taxpayer
• The other person was a qualifying relative
• The taxpayer was not a nonresident alien at any time during the year
• If joint custody it is usually the custodial parent who is treated as providing more than
half the income
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Cost of keeping up a home includes:
Rent Utilities
Mortgage interest Upkeep/repairs
Property taxes Food
Property Insurance Other household expenses
Form 5402EZ, Form 540A or Form 540
Form 540 2EZ Form 540A Form 540
Filing Status All, except MFS Any filing status Any filing status
All dependents
Dependents 0 - 3 allowed All dependents entitled to claim
entitled to claim
$100,000 or less-
Amount of single or H of H Any amount of
Any amount of income
income $200,000 or less - married filing joint income
or qualifying widow(er)
Unemployment
Wages Unemployment Wages Social Security
Sources of Interest Social Security Interest & Dividends
Tier I and
All sources of income
income Scholarships Tier I and Scholarships Tier II RRB
& Fellowships Tier II RRB & Fellowships Taxable pension
Alimony
Adjustments Allowed if the same as federal All adjustments
None
to income adjustments to income
Standard
Allowed Allowed Allowed
Deduction
Itemized All itemized
No itemized deductions Allowed if the same as federal
Deduction deductions
Withholding from W-2 All withholding
Only withholding Estimated tax payments Any estimates
Payments
shown on W-2 Payments with extensions Excess SDI
Excess SDI Extension payment
Personal Exemption Credit
Personal Exemption Credit
Dependent Exemption
Up to 3 dependents
Nonrefundable renters credit
Tax Credits exemption credits All tax credits
Senior exemption credit
Nonrefundable renters credit
Blind Exemption Credit
Senior exemption credit
Child and dependent care
Other
Use 540 2EZ tax table Tax table and rate schedule All taxes
Credits
Community Property State

Community property is all property that is acquired by the taxpayer and spouse while domiciled
in a community property state. Each spouse owns one-half of all community property. Refer to
Chapter one in this text and FTB Pub 1031 for more information.
186
Income reported on married filing separate returns depends on the state of domicile of the
spouses. If one spouse lives in a state that is not a community property state and the other spouse
lives in California which is a community property state; when separate returns are filed the
taxpayer and spouse must each report half of the community income plus all the separate income
earned by that spouse.
Expenses incurred to earn and produce community income is generally divided equally between
the taxpayer and spouse. Deductions that are not attributable to any specific income are
deductible by the spouse that earns them.
Alternative Minimum Tax - 2008
If the taxpayer claims certain types of deductions, exclusions, and credits, the taxpayer may owe
AMT if the total income is more than: $80,017 if married filing jointly or qualifying widow(er);
$60,014 if single or head of household; or $40,007 if married filing separately.
AMT income does not include income, adjustments and items of tax preference related to any
trade or business of a qualified taxpayer who has gross receipts, less returns and allowances,
during the taxable year of less than $1,000,000 from all trades or businesses. Refer to Schedule P
for additional information.
Children Under the Age of 14 with Investment Income
The purpose of Form 3800 and 3803 is to include any investment income that was not
included on the Federal return, so the income can be taxed at the parent’s tax rate. If
the parent’s choose to report the income on the parent’s tax return then use Form
3803. If the child is filing a return, then use Form 3800.
Excess SDI or VPDI Withheld
If California State Disability Insurance (SDI) or Voluntary Plan Disability
Insurance (VPDI) was withheld from the wages by a single employer, at more than 0.8% of the
gross wages, the taxpayer may not claim excess SDI (or VPDI) on Form 540. Contact the
employer for a refund.
The taxpayer may be entitled to claim a credit for excess SDI (or VPDI) only if the taxpayer
meets all the following requirements:
• Two or more employers in the taxable year;
• Received more than $86,698 in wages; and
• The amounts of SDI (VPDI) withheld appear on Form W-2
Refer to the excess SDI worksheet in Form 540 instructions.

California withholding is reported on Form W-2, the Franchise Tax Board verifies all
withholding with the Employment Development Department. The California withholding is
found on Form W-2, Box 17; W-2G, Box 14; 1099MISC, Box 16; or 1099-R, Box 10. Report
the withholding on Line 39 of Form 540 and attach the W-2 to the return. Refer to Chapter 14 in
this text regarding the assembly of this return.
187
Estimated tax is the tax the taxpayer expects to owe in the following tax year, subtracting the
tax the taxpayer expects to have withheld and any credits the taxpayer plans to take. Generally,
the required estimated tax amount is based on the lesser of 90% of the current year tax when
computing the ES worksheet or 100% of the prior year’s tax. The taxpayer must make estimated
payments if they expect to owe $200 ($100 married filing separately) in tax for the next tax year
after subtracting withholding and credits to be less than the smaller of:
• 90% of the shown on the 2008 return; or
• The tax shown on the 2008 tax return
California Credits
California starts to compute the tax with the federal adjusted gross income and makes
adjustments to the income and itemized deductions on Schedule CA. California does not use any
federal credits; the credits are a reduction in tax. Refundable credits can be taken even if there is
no tax liability. Refer to Schedule P instructions and Form 3540 (Credit Carryover Summary)
regarding the carryovers of these credits
Credit Name Description
Child Adoption 50 % of qualifying costs in the year an adoption is ordered not to
exceed $2,500.
Child and Dependent Care Similar to the federal credit, except that CA is based on a
Expenses – FTB 3506 percentage of the federal and is refundable.
Dependent Parent Must use MFS filing status and have a dependent parent
Disabled Access for Similar to federal credit but limited to $125 based on 50%
Eligible Small Business – of qualified expenditures that do not exceed $250.
FTB 3548
Donated Agricultural 50% of the costs incurred for the transportation of
Products FTB 3547 agricultural products donated to nonprofit charitable organizations.
Employer Childcare Employer: 30% of contributions to a qualified plan
Contribution FTB 3501
Employer Childcare Employer: Cost of establishing a childcare program or
Program FTB 3501 constructing a childcare facility.
Enhanced Oil Recovery One third of the similar federal credit and limited to qualified
FTB 3553 enhanced oil recovery projects located within CA
Enterprise Zone Employee 5% of wages from work within an enterprise zone
FTB 3553
Enterprise Zone Hiring Business incentives for enterprise zone businesses
and Sales Use Tax Credit - FTB
3805Z
Joint Custody Head of 30% of tax up to $337 for taxpayers who are single or married
Household filing separately and have a child and meet the support test.
Joint Strike Fighter Wages A percentage of qualified wages paid or incurred in CA in
FTB 3534 connection with the construction of a joint strike fighter.
Joint Strike Fighter 10% of the cost of property placed in service in CA for
Property Costs FTB 3534 ultimate use in joint strike fighter
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Credit Name Description
LAMBRA Hiring and Business incentives for LAMBRA
Sales Use Tax FTB 3807
Low Income Housing Similar to federal credit but limited to low income
FTB3521 housing in California
Manufacturer’s Investment 6 % of the cost of qualified property
FTB 3808
Manufacturers’ Enhanced Percentage of wages paid to qualified disadvantaged individuals
Area
Natural Heritage 55% of the fair market value of any qualified contribution
Preservation FTB 3503
Nonrefundable Renter’s For CA residents who paid rent for their personal residence at
Credit least 6 mos. in the taxable year and had an AGI of less than
$34,936 for single and MFS; and less than $69,872 for MFJ,
H of H and qualified widow(er)
Other State Tax – Net tax paid to the other state or U. S. possession that was also
Schedule S income to CA
Prior Year AMT Must have AMT in the prior year and not have AMT liability
FTB 3510 in 2008
Prison Inmate Labor 10% of wages paid to prison inmates
FTB 3507
Research FTB 3523 Similar to the federal credit but limited to costs of research
activities in CA
Senior Head of Household 2% of CA taxable income with a CA AGI of $60,971 and a
maximum credit of $1,146
Solar or Wind Energy The lesser of 15% of the cost paid or incurred for the
System FTB 3508 purchase and installation of a Solar or Wind Energy System
or the dollar amount per rated watt of the Solar Energy System
Targeted Tax Area Business incentives for TTA businesses
Hiring & Sales or Use Tax
FTB 3809
Child and Dependent Care Expense Credit differs from the federal credit. This is significant
because the California credit is a percentage of the Federal credit. Refer to Form 3506 for
additional information. Differences are as follows:
• California AGI must be $100,000 or less
• Never married persons who live together are treated differently than on the federal
return
• Earned income for a full-time student or disabled spouse is $200 (if 2 or more
qualifiers $400)
• The CA credit is a percentage of the Federal as modified by CA law
• The primary home must be in CA and the taxpayer must be a CA resident.
• The CA credit is refundable
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CA Renter’s Credit
A credit of $ 120 is allowed to qualified renter’s who are joint filers, head of households
or surviving spouses if for 2008 their adjusted gross income is $69,872 or less. All other
qualified renter’s may be entitled to a $60 renter’s credit if their adjusted gross income is
$34,936 or less.
Mental Health Services Tax

If the taxable income is more than $1,000,000, the Mental Health Services Tax is computed
below:
A. Taxable income from Form 540, line 19 . . . . . . . ___________
B. Less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ($1,000,000)_
C. Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ____________
D. Multiply line C by 1% . . . . . . . . . . . . . . . . . . . . . ______.01___
E. Mental Health Services Tax – Enter this amount
here and on Form 540, line 35 . . . . . . . . . . . . . . ____________
Interest and Penalties

Interest will be charged on any late filing or late payment penalty from the original due date to
the date paid. In addition if other penalties are not paid within 15 days, interest will be charged
from the date of the billing notice until the date of the payment. Interest compounds daily and the
interest rate are adjusted twice a year.
Late filing of return: The maximum total penalty is 25% for late filing. The minimum penalty
for filing a return more than 60 days late is a $100 or 100% of the balance due, whichever is less.
Underpayment of Estimated Tax – If the tax due is $200 or more and more than 20% of the tax
shown on line 34 (excluding the tax on lump-sum distribution) or the estimated tax liability is
underpaid for any quarter, a penalty may be due.
Power of Attorney
To obtain information from the Franchise Tax Board for a taxpayer use FTB Form 3520.
Form 3520 grants the following:
• Receive and inspect confidential tax information
• Represent the taxpayer before the Franchise Tax Board
• Sign waivers to extend the statutory period for assessment and determination of
taxes
• Execute settlement agreements
• Execute closing agreements
• Any specific instructions can be listed
Power of Attorney forms do not need to be notarized. The form can be filled out through the
FTB website www.ftb.ca.gov.
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Voluntary Contributions
Voluntary contributions can be made in the amount of $1 or any whole dollar amount. The
contribution will either reduce the amount of refund or increase the amount due. Voluntary
contributions cannot be changed once the return is filed.
Fund Names
• California Seniors Special Fund – If the taxpayer or spouse is 65 years age or
older, and the taxpayer claimed the senior exemptions on line 9 of Form 540, the
taxpayer and spouse can make a combined contribution on $182 ($91 per person).
Contributions in this fund will be distributed to the Area Agency of Aging
Councils to provide advice on senior issues
• Alzheimer Disease/Related Disorders Fund
• California Fund for Senior Citizens
• Rare and Endangered Species Preservation Program
• State Children’s Trust Fund for the Prevention of Child Abuse
• California Cancer Research
• California Firefighters Memorial Fund
• Emergency Food Assistance Program Fund
• California Peace Officer Memorial Fund
• California Military Family Relief Fund
• California Sea Otter Fund
• Municipal Shelter Spay-Neuter Fund
• ALS/ Lou Gehrig Diease Research fund
191
430. The federal tax returns (Form 1040, 1040a or 1040EZ) must be complete
before beginning the California return.
A. True
B. False
431. California is known as a federal ____________ state.

A. AGI
B. Taxable Income
C. Interest
D. Dividends
432. There are three factors that determine whether a taxpayer must file a return. Which of the
following is not one of the three?
A. Filing Status
B. Age
C. Investment Income
D. Number of dependents.
433. The taxpayer must file a return if either the California gross income or the California AGI
is more than the amount shown for the taxpayers filing status, age and number of dependents.
A. True
B. False
434. California exemptions are the same for personal exemptions and dependent exemptions.
A. True
B. False
435. California does not allow an extra exemption if the taxpayer or spouse is blind.
A. True
B. False
436. If the taxpayer is single and has earned income of $8,000 in 2008, the standard deduction
for CA will be which of the following?
A. $ 800
B. $3,692
C. $3,516
D. $6,140
437. A taxpayer can itemize on the Federal or CA return and take the standard deduction on
the other.
A. True
B. False
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438. Which of the following is not true regarding CA forms?
A. File Form 540, 540A or 5402EZ to report income as a resident.
B. The resident return deals with conformity issues by using Schedule CA.
C. File Form 540NR if the tax payer is a nonresident or a part-year resident and use
Schedule CA (540NR).
439. Conformity adjustments are required for California itemized deductions.

A. True
B. False
440. Which of the following is not a requirement for head of household filing status:
A. The taxpayer was unmarried or considered unmarried on the last day of the taxable
year.
B. The taxpayer paid more than one-half the cost of keeping up the home
C. For three months of the year the home was the main home for the taxpayer and
another person who lived with the taxpayer.
D. The other person was a qualifying relative
441. Which of the following is true about a community property state?

A. Community property is all property that is acquired by the taxpayer and spouse while
domiciled in a community property state
B. Each spouse owns one-half of all community property
C. When separate returns are filed the taxpayer and spouse must each report half of the
community income plus all the separate income earned by that spouse.
D. All of the above
442. A taxpayer with 2 dependent children who is head of household filer; earns $80,000 can
use Form 540 2EZ.
A. True
B. False
443. Expenses incurred to earn and produce community income is generally divided equally
between the taxpayer and spouse.
A. True
B. False
444. Which of the following is a component of alternative minimum tax?

A. Deductions
B. Exclusion
C. Credits
D. All of the above
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445. AMT income for CA does not include income, adjustments and items of tax preference
related to any trade or business of a qualified taxpayer who has gross receipts, less returns
and allowances, during the taxable year of less than $1,000,000 from all trades or businesses
A. True
B. False
446. Alternative Minimum Tax is computed on which of the following form for CA?
A. Schedule P
B. FTB 3885A
C. FTB 3506
D. Form 540
447. Form 3800 and 3803 “Children Under the Age of 14” with investment income are the
California counterpart to which Federal forms?
A. Forms 8814 and 8615
B. 6178 and 6251
C. Schedule F and 4797
D. 8582 and 8582CR
448. Excess California State Disability Insurance (SDI) or Voluntary Plan Disability Insurance
(VPDI) withheld from wages by a single employer, at more than 0.8% of the gross wages is
recovered in which of the following manners?
A. Contact the employer for a refund.
B. Enter the excess amount on Form 540 (2008), line 41
C. Apply to the FTB for a refund by writing a letter
449. California withholding is not reported on which of the following forms?

A. W-2G
B. 1099 MISC
C. FTB Form 3801
D. W-2
450. California estimated tax is the tax the taxpayer expects to owe in the following tax year,
subtracting the tax the taxpayer expects to have withheld and any credits the taxpayer plans
to take.
A. True
B. False
451. Which of the following items are not true about the CA Child and Dependent Care
Expense Credit?
A. California AGI must $100,000 or less
B. The CA credit is a percentage of the Federal as modified by CA law
C. The primary home must be in CA
D. The CA credit is nonrefundable
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452. The joint custody head of household credit is only for taxpayers who are single or
married filing separate.
A. True
B. False
453. Schedule S allows a credit for the tax paid to another state, if the tax was on double taxed
CA income.
A. True
B. False
454. Which of the following is true about the California Renter’s Credit in 2008?
A. A nonresident who lived in CA for 7 months can take the renter’s credit
B. A taxpayer filing head of household can earn up to $69,872 and take the credit
C. Both A and B
455. _____________ will be charged on any late filing or late payment penalty from the
original due date to the date paid
A. Penalties
B. Assessments
C. Interest
D. $25
456. The minimum penalty for filing a return more than 60 days late is a $500 or 100% of the
balance due, whichever is less.
A. True
B. False
457. Power of Attorney forms must be notarized.

A. True
B. False
458. Which of the following is not true about Voluntary Contributions to various funds on the
CA return?
A. Voluntary contributions can be made in the amount of $1 or any whole dollar amount.
B. The contribution will either reduce the amount of refund or increase the amount due.
C. Voluntary contributions can be change once the return is filed.
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Chapter 17 - California Residency and Non-Resident
A resident is any individual who is:
• In California for other than a temporary or transitory purpose; or
• Domiciled in California, but outside California for a temporary or
transitory purpose
An individual domiciled in California who is outside California for temporary or

transitory purpose remains a resident. Domicile is defined for tax purposes as the
place where the taxpayer voluntarily establishes himself and his family, not merely for a special
or limited purpose, but with the intention of making the domicile the true, fixed, permanent
home. The domicile is a place where the intent is always to return.
File Form 540, 540A or 5402EZ to report income as a resident. The resident return deals with
conformity issues by using Schedule CA. File Form 540NR if the tax payer is a nonresident or a
part-year resident and use Schedule CA (540NR).
A nonresident is any individual who is not a resident. A part-year resident is any individual
who is a California resident for part of the year and nonresident for part of the year.
Residency is significant because:

• Residents of California are taxed on ALL income including income from sources
outside California
• Nonresidents are taxed only on income from California sources; and
• Part-year residents are taxed on all income received while a resident, and only on
income from California sources while a non-resident
The underlying theory of residency is that the taxpayer is a resident of the place where they have
the closest connections. The following list shows some of the factors to help determine the
residency status:
• Amount of time spent in California versus amount of time spent outside of
California
• Location of spouse and children
• Location of principal residence
• Where the driver’s license was issued
• Where the vehicles are registered
• Where the taxpayer maintains professional licenses
• Where the taxpayer is registered to vote
• Location of banks where the taxpayer maintains accounts
• Location of doctors, dentists, accountants, and attorneys
• Location of church, temple or mosque, professional associations, or social and
country clubs of which the taxpayer is a member
• Location of real property and investments
• Permanence of work assignments in California
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Safe Harbor
Safe harbor is available for certain individuals leaving California under employment-related
contracts. The safe harbor provision states that an individual domiciled in California who is
outside of California for at least 546 consecutive days will be considered a nonresident unless:
• The individual has intangible income exceeding $200,000 in any taxable year
during which the employment-related contract is in effect
• The principal purpose of the absence is to avoid personal income tax
An individual domiciled in California when entering the military is considered a:

• Resident while stationed in California
• Resident while stationed in California on Permanent Change of Station (PCS)
orders and Temporary Duty (TDY) assignments outside California, regardless of
duration
• Nonresident while stationed outside California on PCS orders. Military members
domiciled outside California are considered nonresidents for tax purpose even
when stationed in California on PCS orders. See FTB Pub 1032
Residents are taxed on all income from all sources. Nonresidents of California are taxed only
on income from California sources. Nonresidents of California are not taxed on pensions (HR
10) received after December 31, 1995. Part-year residents are taxed on all income received
while a resident and only on income from California sources while a nonresident.
Types of Income
Specific types of income are treated as follows:
• Wages – have a source where the services are performed. Neither the location of
the employer, nor where the payment is issued, nor the location when the taxpayer
receives payment have an effect on the taxability of income
• Interest and dividends - generally have source where the taxpayer is a resident
• Business income - Nonresident income from California sources includes income
from a business, trade, or profession carried on in California. If the nonresident
business, trade or profession is carried on both within and outside of California.
The part outside of California must be separate and distinct. Only the income
from the part conducted within California is California source income. If there is
no distinction between the business being done within and outside California, then
the apportionment factor (as computed in corporations) must be used to determine
source income
• Pensions and Keoghs (HR 10): Residents: Distributions from employer-
sponsored and self-employment (Keogh) pension, profit sharing, stock bonus
plans, and other deferred compensation arrangements are taxable by California
regardless of where the services were performed. Nonresidents: Distributions are
not taxable by California if received after December 31, 1995
• IRA, Roth IRA, SIMPLE, SEP and Keogh distributions received after
becoming a nonresident are not taxable by California if received after December
31, 1995
• Alimony received and alimony paid are entered on Schedule CA (540NR) only if
the alimony was not reported on the Federal return
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• The gain or loss from the sale of real estate has a source where the property is
located. If the taxpayer sells the property in California, whether or not a resident
the sale is taxable to CA. The basis of the property must be reduced by the
amount of depreciation that would have been allowed had the taxpayer filed a
California return. Real Estate withholding may be required on real estate which
is California source income, report the withholding on Line 40 of Form 540.
Effective January 1, 2003 the 3 1/3% withholding requirement of the sales price
for transfer of California real property of California real property was expanded to
include sales made by California residents. The sale of principal residences and
sales that qualify for tax free exchange under IRC Section 1031 are exempt from
withholding
• Partnership, S-Corporation and trust income when a partner is a part-year resident
during any part of the taxable year, the part–year resident must divide his/her
taxable year into two distinct periods. The taxpayer is taxed on all California
source income for the period when the taxpayer was a resident or a nonresident,
and all California nonsource income for the period when the partner was a
resident. This also applies to shareholders and beneficiaries
• Sale of stock or bonds depends on the source at the time of distribution. If the
taxpayer is a resident it is taxable regardless of source, if the taxpayer is a
nonresident at the time of sale it is not taxable
• Installment sales received by a nonresident on the sale of California property are
taxable by California. However the interest earned on the installment note is not
taxable to the non-resident
• Moving expenses which are reimbursed are taxable to the state to which the
taxpayer moves, regardless of the residency at the time.
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459. An individual domiciled in California who is outside California for
temporary or transitory purposes remains a resident.
A. True
B. False
460. Which of the following is a factor in determining residency in CA?

A. Where the driver’s license was issued;
B. Where the vehicles are registered;
C. Where the taxpayer maintains professional licenses
D. All of the above
461. The safe harbor provision states that an individual domiciled in California who is outside
of California for at least ______consecutive days will be considered a nonresident.
A. 546
B. 60
C. 90
D. 100
462. Which of the following is true about an individual domiciled in California when entering
the military?
A. Resident while stationed in California
B. Resident while stationed in California on Permanent Change of Station (PCS) orders
and Temporary Duty (TDY) assignments outside California, regardless of duration.
C. Nonresident while stationed outside California on PCS orders. Military members
domiciled outside California are considered nonresidents for tax purpose even when
stationed in California on PCS orders.
463. California nonresident return is filed on Form 540 using Schedule CA (540NR)
A. True
B. False
464. Which of the following is not a true statement?

A. Residents are taxed on all income from all sources.
B. Nonresidents of California are taxed only on income from non-California sources.
C. Nonresident of California are not taxed on pensions received after December 31,
1995.
D. Part-year residents are taxed on all income received while a resident and only on
income from California sources while a nonresident.
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465. Which of the following is a true statement regarding wages in California?
A. Wages have a source where the services are performed
B. The location of the employer determines the source of the wages
C. The location of the taxpayer at the time the wages are received determines the source
of the wage.
466. If a taxpayer receives a pension from a California corporation, located within the state,
after the taxpayer has become a non-resident, that pension is taxable to California.
A. True
B. False
467. A California resident worked for a New Jersey company for thirty years and is receiving
a pension, starting in 2008 from that company. The taxpayer did not live or work in
California until after retirement from the New Jersey company. The pension is excluded from
California income.
A. True
B. False
468. Real estate, which is in California _______________ may be subject to real estate
withholding.
A. Depreciable
B. Land only
C. Source Income
469. Which of the following is true about a real estate sale in California?
A. The gain or loss from the sale of real estate has a source where the property is located.
B. If the taxpayer sells the property in California, whether or not a resident the sale is
taxable to CA.
C. The basis of the property must be reduced by the amount of depreciation that would
have been allowed had the taxpayer filed a California return.
D. All of the above
470. Which of the following is not true?

A. Sale of stock or bonds depends on the source at the time of distribution.
B. If the taxpayer is a resident stocks are taxable regardless of source, if the taxpayer is a
nonresident at the time of sale it is not taxable.
C. Installment sales received by a nonresident on the sale of California property are
taxable by California.
D. Interest earned on the installment note is taxable to the non-resident.
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471. Moving expenses which are reimbursed are taxable to the state to which the taxpayer
moves, regardless of the residency at the time.
A. True
B. False
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Chapter 18 - California Conformity, Schedule CA
In general, California law conforms to the Internal Revenue Code (IRC) as of January 1, 2001,
California has not conformed to Federal law made after January 1, 2001,
such as the Jobs Creation and Worker Assistance Act of 2002 or the Jobs &
Growth Tax Relief Reconciliation Act of 2001. California tax returns start
with federal adjusted gross income and primarily Schedule CA is used to
make adjustments where the California law does not conform to the federal
tax law. California is commonly known as an AGI state.
The following list is common items where California does not conform to the Federal:
The tax incentive for “renewal communities” California law does provide a variety of
independent tax incentives to encourage revitalization of specially designated areas.
Wages are generally the same as the federal return if the taxpayer is a full-year resident, with the
following exception:
• Active military pay on a taxpayer or spouse domiciled in community property
state when the spouse is a California resident the spouse is entitled to an
adjustment in wages
• Sick pay that is received under FICA or the Railroad Retirement Act is excluded
in CA
• Foreign earned income excluded on the federal return is taxable to CA and must
be an addition to income
• California qualified stock option is not taxable if:
o Earned income from the corporation is $40,000 or less
o Market value of the options is $100,000 or less
o The total number of shares is less than 1,000
o The corporation issuing the stock designates the stock as California Qualified
Stock
• CA allows an exclusion from gross income for employer provided accident,
health insurance and medical expense reimbursement for registered domestic
partners and partners dependents if not previously deducted. Effective January 1,
2003
Although federal law increased IRC Section 179 expense to $250,000, the maximum deduction
amount under California law is $25,000.
U.S. savings bonds, treasury bills or any other bonds or obligations of the U.S. and its territories
are not taxable to California. Federal tax-exempt interest attributable to non California state
bonds must be added back to CA income.
Interest deduction allowed for interest paid on any loan or indebtedness from any utility
company to purchase energy efficient equipment and products for California residents.
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State tax refund is not taxable to CA. California lottery winnings are not taxable to CA
Passive activity rules for real estate professionals – California does not conform to the federal
law that treats real estate transactions by real estate professionals as nonpassive. Losses are
suspended on Form 3801. Passive activities must be calculated separately, even though CA
conforms due to differences in basis.
Educator expense and the tuition and fees deduction are not allowed
Self-employed health insurance paid on behalf of a domestic partner is deductible for CA.
Student loan interest deduction is not allowed
Unemployment compensation is not taxable to CA
Social security benefits and Tier 1 railroad retirement benefits are not taxable to CA
The clean air fuel first year deduction is reported as an adjustment on Line 33, column B as
part of the subtractions.
State and local income tax (including prior year state taxes) and state disability payments
(SDI), foreign taxes are not deductible as an itemized deduction on California.
Mortgage interest may have to be increased if the taxpayer took a Mortgage Interest Credit on
the Federal return and the mortgage interest was on Form 1040 Schedule A was reduced by the
amount of mortgage interest used to compute the federal credit.
Difference’s in teacher’s employee business expense due to nonconformity to the education

expense deduction.
Gambling losses – may be different since California lottery winnings are not taxable to CA.
Employer-provided Adoption Assistance Exclusion – With regard to adoption of children with

special needs – California has not conformed to federal provisions providing for a potential
increase in the exclusion for the year in which the adoption becomes final or the limitation based
upon the aggregate amount paid in all years. For more information refer to FTB Form 5123.
Net operating loss in general conforms to federal as of January 2001. However there are
continuing differences in law between the Federal and California. Therefore there are different
NOL’s computed each year and different carryover amounts. Generally the carryover from 2005
to future years is 100% for 10 years.
No special tax rates apply to California dividends or capital gains, the varying tax rates are
only for Federal purposes.
IRA basis differences upon distribution arise in the following situations:

• Different deductible IRA amounts
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• Pre-1987 IRA, Keogh, and SEP deductions may have been higher for federal than
CA. basis must be recovered first before reporting income
• Election to use the three year recovery rule for CA purposes if annuity starting
date after July 1, 1986 and before January 1, 1987
California law is the same as federal law in the following areas:

• Roth IRAs – the contribution rules and distribution rules are the same
• Self-employed health insurance deduction - the percentage for 2008 is 100%
• Additional 13 weeks of temporary extended unemployment benefits
• Conformed to the federal provisions regarding disallowance of club dues
• Conformed to federal provisions regarding the disallowance of lobbying and
political expenses
Capital Gain or Loss Adjustment
California Schedule D is used to show the difference between federal and California law. There
may be a difference in basis between the federal and California assets. If special credits are
claimed the basis may be different. The basis of all assets must be computed using the California
law in effect when the asset was acquired and adjust it according to provisions of California law
in effect during the period of ownership.
• Exclusion of gain on qualified small business stock (similar to the federal
exclusion under Section 1202) provides an exclusion of 50% of the gain on the
sale of qualifying small business stock originally issued after 8/10/93 that was
held for more than 5 years. 80% of the issuing corporation must be in California
and attributable to employment located in California. Reported on Schedule D
line 1
• Installment sales – must be reported separately on FTB Form 3805E, even though
in most cases federal and California conform, the installment sales should be
reported separately. The taxpayer may elect not to use the installment sale method
for California by reporting the entire gain on Schedule D or D-1 in the year of sale
• Undistributed capital gains from regulated investment company are not included
income
• Gain or loss on sale of property inherited before 1987
• Capital loss carrybacks
Schedule D-1 (Federal Form 4797)

A difference in basis is common due to different depreciation methods.
FTB Form 3885A – Depreciation
This form is used only if there is a difference in depreciation between Federal and California.
• Before 1/1/87 California did not allow depreciation under the Federal accelerated
recovery class system (ACRS) and the taxpayer must continue to figure California
depreciation in the same manner as prior years
• On or after 1/1/87 – California provides special credits and accelerated write offs
that affect the California basis of qualifying assets. California did not conform to
all changes to federal law enacted in 1993 and this causes California basis of
recovery periods to be different for some assets
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472. California has conformed to the Jobs Creation and Worker Assistance Act
of 2002 and the Jobs & Growth Tax Relief Reconciliation Act of 2001.
A. True
B. False
473. Why is California considered an AGI state?

A. The California adjusted gross income is computed before the tax.
B. California tax returns start with federal adjusted gross income
C. Schedule CA is used to make adjustments where the California law does not conform.
D. All of the above
474. Which of the following is taxable to a California resident?

A. Interest on Arizona municipal bonds.
B. California lottery winnings
C. California state tax refund from the prior year
475. Which of the following regarding the exclusion of small business stock is true?
A. The exclusion is 50% of the gain
B. The stock must be issued after 8/10/93 and held for 5 years
C. 80% of the issuing corporation must be in CA
476. Foreign earned income excluded on the federal return (Form 2555) is taxable to CA and
must be an addition to income.
A. True
B. False
477. What is the maximum amount allowed for a Section 179 expense deduction under CA
law?
A. $35,000
B. $100,000
C. $25,000
D. $10,000
478. The Mental Health Services Tax is imposed on taxable income over?
A. $100,000
B. $10,000
C. $1,000,000
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479. Which of the following is deductible in California?
A. Educator expenses
B. Self-employed health insurance paid on behalf of a domestic partner.
C. Student loan interest
D. Unemployment compensation
480. Individuals in the business of the sale or trade of real estate (Real Estate Professional)
may take a loss on the CA return without limitation on rental property.
A. True
B. False
481. Which of the following itemized deductions may have to be adjusted due to California
law differences?
A. Mortgage Interest
B. Gambling Losses
C. State or Local Income Taxes
D. All of the above
482. California Depreciation Schedule, Form 3885A is used only if there is a difference in
depreciation between Federal and California.
A. True
B. False
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Chapter 19 Ethics – Federal and California
Section 7216 Updated Rules for Tax Preparers (Updated 12/18/2008)
New regulations under Internal Revenue Code Section 7216, Disclosure or Use of Tax Information by
Preparers of Returns, become effective January 1, 2009. The new regulations update regulations that
have been substantially unchanged since the 1970s, and give taxpayers greater control over their
personal tax return information. The statute limits tax return preparers’ use and disclosure of information
obtained during the return preparation process to activities directly related to the preparation of the
return. The regulations describe how preparers, with the informed written consent of taxpayers, may use
or disclose return information for other purposes. The regulations also describe specific and limited
exceptions that allow a preparer to use or disclose return information without the consent of taxpayers.
Revenue Procedure 2008-35 supplements the regulations, in particular Treas. Reg. Section 301.7216-3,
and provides specific form and content guidance to tax return preparers for obtaining consents to
disclose and consents to use taxpayer data in both the paper and electronic environments. Generally,
tax preparers must obtain the signed consent of the taxpayer on paper or electronically before they can
disclose taxpayer return information to anyone or use it for any purpose other than in the context of
preparing and filing the return. Separate consents are required for disclosure(s) and use(s). Consents
must:
• Identify the intended purpose of the disclosure or use;
• Identify the recipient(s) and describe the particular authorized information to be disclosed or
used;
• Include the name of the tax return preparer and the name of the taxpayer;
• Include the applicable mandatory language set forth in section 4.04(a)-(c) of Revenue
Procedure 2008-35 that informs the taxpayer that he is not required to sign the consent and if
he signs the consent, he can set a time period for the duration of that consent;
• Include the mandatory language set forth in section 4.04(d) of Revenue Procedure 2008-35 that
refers the taxpayer to the Treasury Inspector General for Tax Administration if he believes that
his tax return information has been disclosed or used improperly.
• Where applicable, include the appropriate mandatory statement set forth in section 4.04(e) of
Revenue Procedure 2008-35 that informs the taxpayer that his tax return information may be
disclosed to a tax return preparer located outside the U.S;
• Be in 12-point type on 8 1/2 by 11 inch paper. Electronic consents must be in the same type as
the web site’s standard text; and
• Contain the taxpayer’s affirmative consent (as opposed to an “opt-out” clause); and
• Be signed and dated by the taxpayer.
The updated regulations apply to paid preparers, software developers, Electronic Return Originators, and
other persons or entities engaged in tax return preparation services or services that are auxiliary to return
preparation. They also apply to most volunteer tax preparers, for example Volunteer Income Tax
Assistance (VITA) and Tax Counseling for the Elderly (TCE) volunteers and employees and contractors
employed by tax preparation companies in a support role.
Violations could result in imprisonment for up to one year, a fine of not more than $1,000, or both, for
each violation.
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Federal – Circular 230
An individual who prepares and signs a taxpayer' s tax return as the preparer, or who prepares a
tax return but is not required (by the instructions to the tax return or regulations) to sign the tax
return, may represent the taxpayer before revenue agents, customer service representatives or
similar officers and employees of the Internal Revenue Service during an examination of the
taxable year or period covered by that tax return, but, unless otherwise prescribed by regulation
or notice, this right does not permit such individual to represent the taxpayer, regardless of the
circumstances requiring representation, before appeals officers, revenue officers, Counsel or
similar officers or employees of the Internal Revenue Service or the Department of Treasury.
Treasury Department Circular 230 is the publication of regulations governing the practice before
the Internal Revenue Service. The rules outlined in Circular 230 are specifically for Attorneys,
Certified Public Accountants, Enrolled Agents, Enrolled Actuaries and Appraisers also governs
the ethical practices of licensed tax preparers who prepare and sign tax returns.
Due Diligence
(a) In general. A practitioner must exercise due diligence--
(1) In preparing or assisting in the preparation of, approving, and filing tax returns, documents,
affidavits, and other papers relating to Internal Revenue Service matters;
(2) In determining the correctness of oral or written representations made by the practitioner to
the Department of the Treasury; and
(3) In determining the correctness of oral or written representations made by the practitioner to
clients with reference to any matter administered by the Internal Revenue Service.
(b) Reliance on others. A practitioner will be presumed to have exercised due diligence for
purposes of this section if the practitioner relies on the work product of another person and the
practitioner used reasonable care in engaging, supervising, training, and evaluating the person,
taking proper account of the nature of the relationship between the practitioner and the person.
Negotiation of Taxpayer Checks

A practitioner who prepares tax returns may not endorse or otherwise negotiate any check issued
to a client by the government in respect of a Federal tax liability.
Standards for Tax Return Positions and for Preparing or Signing Returns
(a) Realistic possibility standard. A practitioner may not sign a tax return as a preparer if the
practitioner determines that the tax return contains a position that does not have a realistic
possibility of being sustained on its merits (the realistic possibility standard) unless the position
is not frivolous and is adequately disclosed to the Internal Revenue Service. A practitioner may
not advise a client to take a position on a tax return, or prepare the portion of a tax return on
which a position is taken, unless--
(1) The practitioner determines that the position satisfies the realistic possibility standard; or
(2) The position is not frivolous and the practitioner advises the client of any opportunity to
avoid the accuracy-related penalty in section 6662 of the Internal Revenue Code by adequately
disclosing the position and of the requirements for adequate disclosure.
(b) Advising clients on potential penalties. A practitioner advising a client to take a position on a
tax return, or preparing or signing a tax return as a preparer, must inform the client of the
penalties reasonably likely to apply to the client with respect to the position advised, prepared, or
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reported. The practitioner also must inform the client of any opportunity to avoid any such
penalty by disclosure, if relevant, and of the requirements for adequate disclosure. This
paragraph (b) applies even if the practitioner is not subject to a penalty with respect to the
position.
(c) Relying on information furnished by clients. A practitioner advising a client to take a position
on a tax return, or preparing or signing a tax return as a preparer, generally may rely in good
faith without verification upon information furnished by the client. The practitioner may not,
however, ignore the implications of information furnished to, or actually known by, the
practitioner, and must make reasonable inquiries if the information as furnished appears to be
incorrect, inconsistent with an important fact or another factual assumption, or incomplete.
Realistic Possibility Standard

A position is considered to have a realistic possibility of being sustained on its merits if a
reasonable and well informed analysis of the law and the facts by a person knowledgeable in the
tax law would lead such a person to conclude that the position has approximately a one in three,
or greater, likelihood of being sustained on its merits.
The possibility that a tax return will not be audited, that an issue will not be raised on audit, or
that an issue will be settled may not be taken into account.
California - CTEC
If a paid preparer prepares the return, that preparer must register with The California Tax
Education Council unless that person meets one of the following exemptions:
1. Persons licensed with the State Board of Accountancy and their employees
2. Persons who are active members of the State Bar of California and their employees
3. Employees of certain Trust Companies.
4. Persons enrolled to practice before the Internal Revenue Service and their employees.
5. Companies and their employees of Financial Institutions regulated by state or federal
government.
The preparer must complete at least 60 hours of instruction in basic personal income tax law,
theory and practice within the past 18 months. 20 hours of continuing education is required in all
subsequent cycles.
A paid preparer other than those mentioned above must acquire a tax preparer bond in the
amount of $5,000. The California Business and Professions Code Section 22250 requires that a
bond be acquired through a surety company admitted to do business in California and shall be
maintained for each individual preparing returns for another person. The tax preparer is required
to give the client prior to preparing the tax return, their name, address, telephone number and
evidence of compliance with the bonding requirement.
Tax preparers who violate the Business and Professions Code may be subject to a fine of up to
$1,000, a civil penalty of up to $1,000 and up to one year in county jail.
The tax preparer has a requirement to furnish and retain a copy of the return he has prepared.
The return can be kept on magnetic media and shall be kept for a period of at least 4-years from
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the time the return was filed. The taxpayer must sign the return and use either an employer
identification number, a social security number or a personal taxpayer identification number
(PTIN).
Tax Preparer Code of Conduct and Responsibilities

Pursuant to California Business and Professions Code Section 22250 – 22259, a CTEC
Registered Tax Preparer (CRTP):
• Must register as a tax preparer with the California Tax Education Council
• Must maintain a $5,000 tax preparer bond issued by a surety company admitted
to do business in California. A tax preparer shall provide to the survey company
proof that he or she is at least 18 years of age before a bond can be issued
• Must identify to the surety company all preparers employed or associated with
the tax preparer securing the bond
• Must file an amendment to the bond within 30 days of any change in the
information provided in the bond
• Must not conduct business without having a current surety bond in effect
• Must cease doing business as a tax preparer upon cancellation or termination of
bond until a new bond is obtained
• Must show evidence of current bond upon the request of any state or federal
agency or law enforcement agency
• Must, prior to rendering any tax preparation services, provide the customer, in
writing, with the tax preparer’s name, address, telephone number, and evidence of
compliance with the bonding requirement
• Must not make fraudulent, untrue or misleading statements or representations
which are intended to induce a person to use their tax preparation services
• Must not obtain the signature of a customer on a tax return or authorizing
document, which contains blank spaces to be filled in after it has been signed
• Must not fail or refuse to give a customer, for their own records, a copy of any
document requiring the customer’s signature within a reasonable time after the
customer signs
• Must not fail to maintain a copy of any tax return prepared for a customer for
four years from the later of the date of the return or the completion date of the
return
• Must not engage in advertising practices, which are fraudulent, untrue or
misleading including assertions that the tax preparer bond in any way implies
licensure or endorsement of tax preparer by the State of California
• Must not violate provisions of Section 17530.5 or 7216 of Title 26 of the United
States Code prohibiting tax preparers from disclosing any information obtained by
the business of preparing federal and state (1) consented to, in writing, by the
taxpayer in a separate document; (2) expressly authorized by law; (3) necessary
for the preparation of the return; and (4) pursuant to court order
• Must not fail to sign the customer’s tax return when payment for services
rendered has been made
• Must not fail to return upon the demand or on behalf of a customer, records or
other data provided to the tax preparer by the customer
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• Must not give false or misleading bond information to a consumer or giving false
or misleading information to a surety customer in obtaining their tax preparer
bond
• Must apply for their Certificate of Completion within 18 months after completing
their 60-hours of qualifying education from an approved provider
• Must complete on an annual basis, not less than 20-hours of continuing education
from an approved curriculum provider (12 hours federal, 4 hours California, and 4
hours of either federal or California)
Preparer Penalties
When a person prepares a tax return for a fee without the appropriate law designation, he or she
could be fined up to $1,000 for each illegally prepared tax return. According to California
Business and Professions Code Section 22253.5, the Franchise Tax Board may notify the
California Tax Education Council when it identifies an individual who has violated the law. The
California Tax Education Council shall then notify the Attorney General, a district attorney, or a
city attorney. The entities may do the following: (1) Cite individuals preparing tax returns in
violation of this chapter; (2) Levy a fine up to one thousand dollars ($1,000) per violation; and
(3) issue a cease and desist order, which shall remain in effect until the individual has come into
compliance with the provisions of this chapter.
The following are some other penalties that can be assessed against tax preparers:
Failure to furnish a copy of the return to the taxpayer - $50 per return up to $25,000.
Failure to sign a return - $50 per return up to $25,000.
Failure to furnish preparer’s identification number $50 per return up to $25,000.
Failure to maintain copies of the return - $50 per return up to $25,000
Understatement of taxpayer’s liability due to unrealistic position - $250 per return.
Understatement due to preparer’s willful or reckless conduct - $1,000 per return.
Failure to maintain records of preparers in office - $50 per preparer up to $25,000.
Improper disclosure of return information - $250 for each disclosure up to $10,000.
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483. New regulations under Internal Revenue Code Section 7216, Disclosure or Use of Tax
Information by Preparers of Returns, become effective January 1, 2009.
A. True
B. False
484. Which of the following is true regarding a consent form for disclosure of taxpayer
information?
A. Identify the intended purpose of the disclosure or use
B. Include the name of the tax return preparer and the name of the taxpayer
C. Contain the taxpayer’s affirmative consent (as opposed to an “opt-out”
clause).
D. All of the above
485. Which of the following is an item included in the definition of due diligence?
A. In preparing or assisting in the preparation of, approving, and filing tax returns,
documents, affidavits, and other papers relating to Internal Revenue Service matters;
B. Reliance on others.
C. In determining the correctness of oral or written representations made by the
practitioner to clients with reference to any matter administered by the Internal
Revenue Service.
D. All of the above
486. A practitioner who prepares tax returns may not endorse or otherwise negotiate any check
issued to a client by the government in respect of a Federal tax liability.
A. True
B. False.
487. A practitioner may not sign a tax return as a preparer if the practitioner determines that
the tax return contains a position that does not have a _______________ of being sustained
on its merits
A. Assurance from the taxpayer
B. A consultation with a colleague assurance
C. Realistic possibility
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488. A practitioner advising a client to take a position on a tax return, or preparing or signing a
tax return as a preparer, reasonably ________________likely to apply to the client with
respect to the position advised
A. Must inform the client of the penalties
B. Must consult with a colleague
489. A practitioner advising a client to take a position on a tax return, or preparing or signing a
tax return as a preparer
A. Generally may rely in good faith without verification upon information furnished by
the client
B. Must make reasonable inquiries if the information as furnished appears to be incorrect
C. May not ignore the implications of information furnished
D. All of the above
490. A position is considered to have a realistic possibility of being sustained on its merits if
the position
A. Has approximately a one in three, or greater, likelihood of being sustained on its
merits
B. Has a guarantee that it will not be audited
C. Has not been audited to the preparer’s knowledge
491. Which of the following is not an exception to the requirement of registering annually
with The California Tax Education Council
A. Persons who are registered with the State Board of Accountancy
B. Persons who are active members of the State Bar of California
C. Practitioners who have been registered previously with CTEC
492. How many hours must be completed annually to renew your registration with CTEC?
A. 20 hours
B. 30 hours
C. 60 hours
D. 15 hours
493. The California Business and Professions Code Section 22250 requires that a bond be
acquired through a surety company admitted to do business in California and shall be
maintained for each individual preparing returns for another person. Which of the following
is the required amount of the bond?
A. $1,000
B. $5,000
C. $10,000
D. $12,000
213
494. Tax preparers who violate the Business and Professions Code may be subject to a fine of
up to $1,000, a civil penalty of up to $1,000 and up to one year in county jail.
A. True
B. False
495. A CA tax preparer has a requirement to ______________________he has prepared. The

return can be kept on magnetic media and shall be kept for a period of at least 4-years from
the time the return was filed.
A. Furnish and retain a copy of the return
B. Electronically file the return if it meets the qualifications
C. Sign the return
D. All of the above
496. Which of the following is a requirement of a registered CTEC preparer?

A. Must identify the surety company all preparers employed or associated with the tax
preparer securing the bond
B. Must not conduct business without having a current surety bond in effect
C. Must not make fraudulent, untrue or misleading statements or representations which
are intended to induce a person to use their tax preparation services
D. All of the above
497. Tax preparers must be at least how old before a bond can be issued?
A. 18 years old
B. 21 years old
C. 16 years old
D. 25 years old
498. If the preparer gives an estimate of the tax owed or amount to be refunded the taxpayer
may sign a blank tax return or authorizing document to be filed by the tax preparer
A. True
B. False
499. Which of the following must be supplied to the taxpayer before completing the return?
A. Tax Preparer’s name
B. Address
C. Phone number
D. All the above
500. Which of the following best describes the 20 hours of continuing education required
annually?
A. 12 hours federal, 4 hours California, 4 hours either California or Federal
B. 16 hours Federal and 4 hours California
C. 20 hours Federal
214
Name ___________________________ Date _______________
2009 - 60 Hour “Become A Tax Preparer” Course – Answer Sheet
Question Answer Question Answer Question Answer Question Answer Question Answer
Chap 1 1 51 101 151 201
2 52 102 152 202
3 53 103 153 203
4 54 104 154 204
5 55 Chap 5 105 155 205
6 56 106 Chap 6 156 206
7 57 107 157 207
8 58 108 158 208
9 59 109 159 209
10 60 110 160 Chap 7 210
11 Chap 3 61 111 161 211
12 62 112 162 212
13 63 113 163 213
14 64 114 164 214
15 65 115 165 215
16 66 116 166 216
17 67 117 167 217
18 68 118 168 218
19 69 119 169 219
20 70 120 170 220
21 71 121 171 221
22 72 122 172 222
23 73 123 173 Chap 8 223
24 74 124 174 224
25 75 125 175 225
26 76 126 176 226
27 77 127 177 227
28 78 128 178 228
29 79 129 179 229
30 80 130 180 230
31 Chap 4 81 131 181 231
32 82 132 182 232
33 83 133 183 233
34 84 134 184 234
35 85 135 185 235
36 86 136 186 236
37 87 137 187 237
Chap 2 38 88 138 188 238
39 89 139 189 239
40 90 140 190 240
41 91 141 191 241
42 92 142 192 242
43 93 143 193 243
44 94 144 194 244
45 95 145 195 245
46 96 146 196 246
47 97 147 197 247
48 98 148 198 248
49 99 149 199 249
50 100 150 200 250
215 720
Name__________________________________ Date__________________
2009 - 60 Hour “Become A Tax Preparer” Course – Answer Sheet
Question Answer Question Answer Question Answer Question Answer Question Answer
251 301 351 401 451
252 302 352 402 452
253 303 353 403 453
254 304 Chap 12 354 404 454
255 305 355 405 455
256 306 356 406 456
257 307 357 407 457
Chap 9 258 308 358 408 458
259 309 359 409 Chap 17 459
260 310 360 410 460
261 311 361 411 461
262 312 362 Chap 14 412 462
263 313 363 413 463
Chap 10 264 314 364 414 464
265 315 365 415 465
266 316 366 416 466
267 317 367 417 467
268 318 368 418 468
269 319 369 419 469
270 320 370 420 470
271 321 371 421 471
272 322 372 422 Chap 18 472
273 323 373 423 473
274 324 374 Chap 15 424 474
275 325 375 425 475
276 326 376 426 476
277 327 377 427 477
278 328 378 428 478
279 329 379 429 479
280 330 380 Chap 16 430 480
281 331 381 431 481
282 332 382 432 482
283 333 383 433 Chap 19 483
284 334 384 434 484
285 335 385 435 485
286 336 386 436 486
287 337 387 437 487
288 338 388 438 488
289 339 389 439 489
290 340 390 440 490
291 341 391 441 491
292 342 392 442 492
293 343 Chap 13 393 443 493
294 344 394 444 494
295 345 395 445 495
Chap 11 296 346 396 446 496
297 347 397 447 497
298 348 398 448 498
299 349 399 449 499
300 350 400 450 500
216 720
Personal Information Form
The following information is required for completion of the certificate:
Enter last four digits of the order number from your confirmation email:
______________ EX: yhst-69000032383144-1486 from Taxeaseeed.com
Name (as it should appear on Certificate):
Shipping Address for Certificate:

_____________________________________________________________
_____________________________________________________________
_____________________________________________________________
Daytime Phone: __________________________
Last 6 Digits of your Social Security Number ________________________
Submission Instructions
1. Be sure your name and date is on the front of each page of the answer sheet.
Complete the personal information above and the evaluation on the next page.
2. Mail or fax the answer sheet to:

TaxEase, LLC Fax Number
39270 Paseo Padre Pkwy #624 510-779-5251
Fremont, CA 94538
3. Allow ten (10) days for grading.
217 720
TaxEase, LLC
2009 - 60 Hour “Become A Tax Preparer” Evaluation
Please take a moment to let us know how we did…
1. Was the material effective in helping you learn the basic facts regarding tax return
preparation?
________________________________________________________________________
____________________________________________________________
2. Are the tax facts useful for the future?

________________________________________________________________________
____________________________________________________________
3. Was the content relevant to you?

________________________________________________________________________
____________________________________________________________
4. Was the material presented in an effective way?

________________________________________________________________________
____________________________________________________________
5. Did the format aid in your studies?

________________________________________________________________________
____________________________________________________________
218 720

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BecomeATaxPreparer2009 1

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2009 - 60 Hour

Federal and California

Tax Ease, LLC

TaxEase’s objective is to:

IRS Pub. 17 Your Federal Income Tax

IRS: (800) 829-3676 www.irs.gov

TaxEase, LLC or FAX 510-779-5251

CERTIFICATION AND INSTRUCTIONS .......................................................................................................................4

CHAPTER 1 - THE BASICS..............................................................................................................................................9

CHAPTER 2- FILING STATUS AND DEPENDENTS ..................................................................................................23

CHAPTER 3 - WAGES AND 1099’S ..............................................................................................................................39

CHAPTER 4 - INTEREST AND DIVIDENDS ...............................................................................................................54

CHAPTER 5 – CANCELLATION OF DEBT, REFUNDS, ALIMONY AND BUSINESS INCOME...........................61

CHAPTER 6 - CAPITAL ASSETS ..................................................................................................................................79

CHAPTER 7 - TYPES OF IRA’S AND EMPLOYER SPONSORED PENSION PLANS - DISTRIBUTIONS............95

CHAPTER 9 - UNEMPLOYMENT COMPENSATION, SOCIAL SECURITY BENEFITS AND MISCELLANEOUS

CHAPTER 10- ADJUSTMENTS TO INCOME ............................................................................................................119

CHAPTER 11 – ITEMIZED DEDUCTIONS ................................................................................................................131

CHAPTER 12 - TAXES AND CREDITS ......................................................................................................................150

CHAPTER 13 - PAYMENTS, WITHHOLDING AND EARNED INCOME CREDIT................................................167

CHAPTER 14 – REFUNDS, AMOUNT DUE & ELECTRONIC FILING ...................................................................175

CHAPTER 15 – VARIOUS TAXES ..............................................................................................................................181

CHAPTER 16 –THE BASIC CALIFORNIA RETURN ................................................................................................184

CHAPTER 17 - CALIFORNIA RESIDENCY AND NON-RESIDENT .......................................................................196

CHAPTER 18 - CALIFORNIA CONFORMITY, SCHEDULE CA..............................................................................202

CHAPTER 19 ETHICS – FEDERAL AND CALIFORNIA ..........................................................................................207

PERSONAL INFORMATION FORM ...........................................................................................................................217

2009 - 60 HOUR “BECOME A TAX PREPARER” EVALUATION ...........................................................................218

From 2008 Pub 17

Real Estate Taxes - NEW IN 2008

Example: Standard Deduction Worksheet – 2008 Form 1040 Line 40

Deduction for Exemptions Worksheet – 2008 Form 1040 Line 42

4. For most people filing a return is required when:

8. The tax return for a calendar year taxpayer is due on:

10. Form 4868 is used:

11. Which of the following is not true regarding interest?

12. A return should be amended for the following reasons, except:

13. Which of the following is not an accuracy related penalty?

22. Which of the following is not a preparer penalty?

30. Which of the following is allowed on Form 1040A?

34. A regular fiscal year is a 12-month period that ends:

California Registered Domestic Partners (RDP) and Same-Sex Married Couples

That’s the General, Here are some Specifics on Filing Status

Married Filing Separate

Items Related to Married Filing Separate

California and Married Filing Separate

Separate property is:

Eligible foster child

If a governmental agency or a tax-exempt child placement agency makes payments to the

More than half the year

Multiple support agreement

Parent (father or mother)

Stepchild Parent Grandparent Uncle Aunt

(3) A nephew or niece may qualify only if he or she

The spouse is never considered your dependent.

Support Test (To Be a Qualifying Child)

Refer to Pub 17 for more information

California Exemption Credits

38. Which of the following is true regarding filing status?

44. Which of the following is not a community property state?

57. Which of the following is not a test for qualifying child

59. Which of the following is a definition of an eligible foster child?