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Thoughts From an EA | Test Your Tax Knowledge

Test Your Tax Knowledge is provided courtesy of Arthur EA Review Home Study Course

PART 1
Individuals

1. Question 15. (1 point – True/False)

John and Bill lived together in a home owned by Bill in 1997. Their financial arrangement was that each would pay one-half of all expenses connected with the home. During the year John and Bill each paid $620 in real estate taxes on the home's total annual tax bill of $1,240. Assuming John claims itemized deductions in 1997, John may deduct the $620 he paid for real estate taxes.

False. The following 2 tests must be met for any tax to be deductible:

1. The tax must be imposed on you.
2. The tax must be paid during your tax year.

2. Question 24. ( 2 point – multiple choice)

During an all-employee awards ceremony, Pedals Company gave Mollie a new bicycle for her outstanding safety record. This award was presented to Mollie for her services to the company and in accordance with Pedal's qualified employee achievement awards program. The bicycle cost Pedals $1,200 and has a fair market value of $1,700. What amount must Mollie include in income?

A. $1,200.
B. $ -0-.
C. $1,700.
D. $ 500.

B. $ -0-.

The limit for total awards that can be excluded from wages from nonqualified award plans is $400 per year, and the total awards that can be excluded from both qualified and non-qualified plans is $1,600 per year. The cost to the employer is the determining factor for these limits. The question states that the award was presented in accordance with a qualified achievement award plan. Therefore, the limit is $1,600. Although the FMV of the bicycle is over $1,600, the actual cost is $1,200 and therefore not included in Mollie's income.

3. Question 67 ( 3 point - multiple choice)

Ms. Orchard purchased a two unit duplex in 1985. She lived in one unit and rented out the other unit until she sold the duplex in February, 1997. In April, 1997 she bought and lived in a small single home. She did not replace the rental property. Her records showed:

DUPLEX Original Cost $100,000 Capital Improvements $30,000 Depreciation until date of sale (rental unit only) $40,000 Selling Price $250,000 Selling Expenses $20,000 NEW HOME Purchase Price $150,000

What is the amount of gain that Ms. Orchard may postpone in 1997?

A. $150,000
B. $140,000
C. $ 50,000
D. NONE

C. $50,000.

Ms. Orchard was able to postpone her total gain on sale of the personal portion of the duplex. The gain from the sale of the duplex that was used as a rental cannot be postponed. This question has some interesting twists. For example, the question states that the rental property was NOT replaced. However, she replaced the part of the duplex that was used as her personal residence with a small single home. Also, this transaction was completed in April 97 before May 6, 1997 when the new personal residence rules became effective. Under the old rules, you MUST postpone the gain on the sale of your personal residence if you buy or build a new main home within the replacement period, which is a period of 2 years before or 2 years after the sale of your old home. And, the new home must cost as least as much as the adjusted sales price of the old home. She met both of these rules.

In addition, the question does not identify the capital improvements. We have to assume they are to be equally divided between the owner's unit (personal portion) and the rental unit. The question asks for the postponed gain, but I have included the calculation for both the personal portion and the rental portion for clarity:

Amount realized Personal Portion 50% Rental Portion 50% Selling Price $250,000/2 &125,000 $125,000 Less: Selling expenses $20,000/2 ( 10,000) ( 10,000) Amount realized $115,000 $115,000 Less: Basis of duplex     Cost of duplex $100,000/2 $50,000 $50,000 Capital improvements $30,000/2 15,000 15,000 Less: depreciation on rental portion   (40,000) Adjusted basis $65,000 $25,000       Gain on sale $ 50,000 $ 90,000 Taxable gain - rental portion   $ 90,000 Computation of gain postpones and adjusted basis of new home     Cost of new home $150,000 N/A Less: gain postponed - personal portion ( 50,000) N/A Adjusted basis of new home $100,000 N/A

PART 2
Small Business & Partnership

4. Question 58. (3 point – multiple choice)

In 1995, Ben purchased a truck for $15,000. In 1995, he claimed a $3,000 section 179 deduction and began depreciating the truck. He sold the truck in 1997 for $13,000. Prior to the sale, Ben claimed MACRS deductions of $8,000. Had Ben claimed straight line depreciation, he would have claimed $6,000 prior to the sale. What amount of gain on the sale is treated as ordinary income in 1997?

A. $ 2,000
B. $ 8,000
C. $ 9,000
D. $ 11,000

C. $9,000.

The amount of gain treated as ordinary income on the sale, exchange, or involuntary conversion of section 1245 property is limited to the lower of: 1. The gain realized, or 2. The depreciation claimed on the property. Depreciation includes all depreciation claimed from ALL depreciation methods plus any section 179 deduction. Computed as follows:

Sales Price     $13,000 Less Adjusted Basis: Cost   $15,000   Section 179 $3,000     Depreciation $3,000     Total depreciation   (11,000)   Adjusted basis     ($ 4,000) Gain realized     $ 9,000

The section 1245 recapture amount is the lesser of the gain realized $9,000 or the depreciation taken which includes section 179 for a total of $11,000. The lesser of the two amounts is the gain realized of $9,000 and is the amount to be recaptured (treated as ordinary income) under section 1245.

5. Question 65. (3 point – multiple choice)

Jane has a 30% interest in a cash basis general partnership. Her adjusted basis in the partnership was $50,000 at the beginning of 1997. There were no distributions to Jane during the year. On August 1, 1997, the partnership borrowed $200,000 for the following reasons:

Purchase depreciable business equipment $ 30,000 Pay balance on existing note in full $170,000

All of the partners are personally liable for all partnership debts. The partnership incurred a $250,000 loss in 1997. What amount can Jane claim as a loss from the partnership on her 1997 individual income tax return?

A. $50,000
B. $59,000
C. $65,000
D. $75,000

B. $59,000

A partner's distributive share of partnership loss is allowed only to the extent of the adjusted basis of the partner's interest in the partnership. A partner's basis is increased by an increased share of partnership liabilities and decreased by a decreased share of liabilities. Jane’s loss is limited to her adjusted basis or $59,000. Computed as follows:

Jane's basis as of January 1, 1997   $50,000 Activity during the year     Add: New loan ($200,000 X 30%) $60,000   Less: Payoff of old loan ($170,000 X 30%) (51,000)   Increase in note balance   9,000 Jane's basis as of December 31, 1997   $59,000

PART 3
Corporations, S-Corporations, Fiduciaries, and Estate & Gift Tax

6. Question 46. (3 point – multiple choice)

During 1997, Jake transferred land having an adjusted basis of $35,000 and a fair market value of $47,000 to Otter corporation. In exchange for the land he received $5,000 cash, equipment having an adjusted basis of $3,000 and a fair market value of $5,000 and 80% of Otter corporation's only class of stock outstanding. The stock received by Jake had a fair market value of $37,000. What is the amount of gain that Jake will recognized?

A. $ -0-
B. $10,000
C. $12,000
D. $20,000

B. $10,000

Background: If you transfer property (or money and property) to a corporation in exchange for stock in that corporation, and immediately afterwards you are in control of the corporation, the exchange is usually not taxable. To be in control of a corporation, you or your group of transferors must own, immediately after the exchange, at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the outstanding shares of each class of nonvoting stock. If in an otherwise nontaxable exchange of property for corporate stock, you also receive money or property other than stock, you may have a taxable gain. You are taxed only up to the amount of money plus the fair market value of the other property you receive. The rules for figuring the taxable gain generally follow those for a partially nontaxable exchange. These rules state that you are taxed on the gain you realize, but only to the extent of the cash and FMV of unlike property you receive. Computed as follows:

Amount Realized Fair Market Value of stock received $ 37,000 Cash Received 5,000 Equipment received $ 5,000 Total amount realized $ 47,000 Less: Adjusted basis of land ( 35,000) Realized gain $ 12,000

Gain Recognized Cash received $ 5,000 FMV of equipment received $ 5,000 Recognized gain $ 10,000

Recognized gain limited to the lesser of realized gain or recognized gain or $10,000

7. Question 75. (3 point – multiple choice)

Candace died on January 20, 1997. The assets included in her estate were valued as follows:

1-20-97 7-20-97 10-20-97 House $900,000 $800,000 $ 700,000 Stocks $850,000 $600,000 $1,000,000

The executor sold the house on October 20, 1997 for $700,000. The alternative valuation date was properly elected. What is the value of Candace's estate?

A. $1,750,000
B. $1,700,000
C. $1,400,000
D. $1,300,000

C. $1,400,000.

A decedent's gross estate includes the value of all property to the extent of the decedent's interest in the property at the time of death. However, an election can be made by the executor to use the alternate valuation method. Under this method, property included in the decedent's gross estate is valued as of a date other than that of death. The alternative valuation date is six months after date of death. In this question, the alternate valuation date is 7-20-97 and is used for the valuation of Candace's gross estate.

Property sold between the date of death and the alternate valuation date is valued as of the date it is sold for the sales price. Property sold AFTER the six month period (alternate valuation date) is valued as of the alternate valuation date. Both assets were sold AFTER the alternate valuation date and therefore the alternate valuation date is used to value the estate.

House	$ 800,000
Stocks	$ 600,000
Gross value of estate	$1,400,000

PART 4
Ethics, Recordkeeping Procedures, Exempt Organizations, Retirement Plans, Practitioner Penalty Provisions, Research Materials and Collection Procedures

8. Question 3. (1 point – True/False)

In the event an applicant for enrolled agent status is denied by the Director of Practice, he or she may file an appeal of that decision with the Deputy Commissioner of Internal Revenue Service.

False.
The applicant has 30days after receipt of the notice of denial to file a written appeal, together with his/her reasons in support thereof, to the Secretary of the Treasury.

9. Question 43. (2 point – multiple choice)

When an attorney, CPA or enrolled agent knows that a client has backdated a document which the client wants the representative to submit to the IRS, the representative has a duty to do which of the following:

1. Submit the document (providing the client has provided the representative a document declaring him/her free from malpractice liability).
2. Notify the local district attorney of a possible crime.
3. Submit another document which will offset the gain anticipated by the submission of the false document.
4. Advise the client promptly of such non-compliance, error or omission.

D. Advise the client promptly of such non-compliance, error or omission. There is no requirement to notify anyone other than the client.