Cruz2007-v1 - 16 - Solutions Manual
CHAPTER 5
DISCUSSION QUESTIONS AND PROBLEMS
Discussion Questions
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1. What is the difference between deductions from AGI and deductions for AGI?
Answer:
For AGI expenditures are outflows made for the production of income or for a trade or business and are included in the calculation of adjusted gross income. From AGI deductions are primarily personal expenditures that are allowed to reduce taxable income.
2. What are the six types of personal expenses that can be classified as itemized deductions on Schedule A, Form 1040?
Answer:
Personal expenses allowed as itemized deductions include medical expenses, state and local taxes, interest, charitable gifts, casualty losses, and miscellaneous deductions.
3. Describe the concept of a 7.5% floor for medical deductions.
Answer:
The 7.5% floor means that medical expense deductions are not allowed until the total medical deductions exceed 7.5% of AGI. Thus, medical expenditures, net of insurance reimbursements, must be substantial in order to gain any tax benefit.
4. Can an individual take a medical deduction for a capital improvement to their personal residence? If so, how is it calculated?
Answer:
For medical capital expenditures that improve the taxpayer's property, the deduction is available only to the extent that the medical expenditure exceeds the increase in the FMV of the residence.
5. What are the general requirements for a medical expense to be considered deductible?
Answer:
Medical expenses are allowed as itemized deductions to the extent the expenses exceed 7.5% of adjusted gross income and are not be reimbursed. Qualified medical care expenses include amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease or for the purpose of affecting any structure or function of the body, for transportation primarily for and essential to medical care, for qualified long-care services, and for insurance covering medical care.
6. When are travel costs deductible as medical costs? How are medical travel costs calculated?
Answer:
Travel costs are deductible when incurred for transportation primarily for and essential to medical care. There is no deduction allowed for travel expenses unless there is no significant element of personal pleasure, recreation, or vacation in the travel away from home. Transportation costs could include such items as cab, bus, or train fares, as well as expenses for a personal auto. The cost of the transportation must be primarily for, and essential to, deductible medical care. The amount of the deduction for the use of a personal auto for transportation for medical care can be calculated using the actual cost of operating the car for medical purposes or the optional standard mileage allowance.
7. How do reimbursements from health insurance policies affect the amount of the medical deduction? Can a taxpayer take a deduction for premiums paid for health insurance? What happens if an insurance reimbursement for medical expenses is received in a subsequent tax year?
Answer:
Any insurance reimbursements or partial reimbursements must be subtracted from the gross medical expenses to give the net medical expenses that are subject to the 7.5% AGI limitation. The insurance reimbursement would be included in income to the extent that benefit was received in the prior year. Health insurance premiums are only deductible if the premiums are paid with after-tax funds (not in an employer pre-tax plan).
8. What are the four major categories of deductible taxes on individual returns?
Answer:
The four major categories of deductible taxes are personal property taxes, local real estate taxes, other state, and local taxes, and foreign taxes.
9. For a tax to be deductible as an itemized deduction, what three tests are required?
Answer:
State or local property taxes must meet the three tests in order to be deductible. The tax must be levied on personal property, the tax must be an "ad valorem tax,” and the tax must be imposed at a minimum on an annual basis with respect of personal property.
10. If state or local income taxes are deducted on the current year’s tax return, what is required if the taxpayer receives a refund in the next year?
Answer:
If a refund was received, the tax preparer must include the refund in income for the current year (assuming the taxpayer itemized his/her return and deducted state taxes in the previous year).
11. What options does the taxpayer who paid foreign taxes have when considering his or her tax treatment? Which option is usually more tax beneficial?
Answer:
The tax code allows the option of either taking a credit for foreign taxes or deducting the taxes. Typically, it is more beneficial for individual taxpayers to utilize the credit rather than the deduction because the credit is a dollar for dollar reduction in taxes. The deduction just reduces taxable income and the net tax effect is dependent on the taxpayer’s tax rate.
12. What is qualified residence interest? Are there any limits to the deductibility of qualified residence interest?
Answer:
Qualified residence interest is any interest that is paid or accrued during the taxable year on acquisition indebtedness or home equity indebtedness with respect to any qualified residence of the taxpayer. Taxpayers are allowed a deduction for qualified residence interest on their principle residence and a second residence selected by the taxpayer. The aggregate amount treated as acquisition indebtedness for any period cannot exceed $1,000,000 ($500,000 for married individuals filing separate returns). The $1,000,000 limitation refers to the amount of principle of the debt and not the interest paid.
13. What is a home equity loan? Is the interest tax deductible? Are there any limits to the deductibility of home equity loan interest?
Answer:
Home equity loans are loans that are secured by a qualified residence and in an amount that does not exceed the fair market value of the residence less the acquisition debt. The aggregate amount treated as home equity indebtedness for any period cannot exceed $100,000 ($50,000 for married filing separately).
14. What is investment interest? What are the limits to the deductibility of investment interest?
Answer:
Typical items that comprise investment income are interest income, dividends, royalties, and capital gains. The deduction of investment interest expense is limited to the net investment income for the year.
15. Donations to what type of organizations are tax deductible?
Answer:
Deductions subject to limitations are allowed for donations to public charities, private foundations, and organizations such as war veterans' organizations, fraternal orders, cemetery companies, and certain non-operating private foundations.
16. Distinguish between the tax treatment for donations to charitable organizations of cash, ordinary income property, and capital gain property.
Answer:
Generally, if capital gain property is donated to a public charity, the donation is the FMV of the property. Cash given to a private foundation would be limited to 30% of AGI, whereas capital gain property given to the same organization would be limited to 20% of AGI. The 30% limitation also applies to any contribution (cash or property) to charities that are not 50% limitation charities such as war veterans' organizations, fraternal orders, cemetery companies, and certain non-operating private foundations.
17. What happens to a charitable contribution that is in excess of the AGI limits?
Answer:
The excess charitable contribution can be carried forward for 5 years. In carryover years, current contributions are deducted first. The carryover is considered even when using the standard deduction.
18. Define personal casualty loss. Include in your discussion the concepts of sudden, unexpected or unusual.
Answer:
A personal casualty loss includes losses of personal property, such as personal residence, personal auto, and vacation home. A sudden event is noted as an event that is swift, not gradual or progressive. An unexpected event is defined as an event that is ordinarily unanticipated and occurs without the intent of the taxpayers. An unusual event is one that is extraordinary and nonrecurring.
19. How is a personal casualty loss calculated? Include in your discussion how the determination of the loss is made and limits or floors placed on personal casualties.
Answer:
In general, the casualty loss is the lesser of the FMV immediately before the casualty reduced by the FMV immediately after the casualty, or the amount of the adjusted basis for determining the loss from the sale or other disposition of the property involved. There are two limitations on personal casualty deductions. First, each separate casualty is reduced by $100 ($100 per casualty, not $100 per item of property). The second and more substantial limitation is the 10% of AGI limitation. In order to obtain any benefit from a casualty loss, the loss must be in excess of 10% of AGI. Because of the 10% limitation, most taxpayers do not benefit from casualty losses unless the loss was substantial.
20. Give three examples of miscellaneous itemized deductions. Why are deductions of miscellaneous itemized deductions often limited?
Answer:
Three examples of miscellaneous itemized deductions include unreimbursed employee business expenses, tax return preparation fees, and gambling losses (to extent of gambling income.)
21. What is usually the largest miscellaneous deduction for individual taxpayers and are there any special reporting issues associated with it?
Answer:
Usually the largest miscellaneous deduction for individual taxpayers is unreimbursed employee business expenses and are the most likely to cause the total miscellaneous deduction to exceed the 2% floor. If any travel, transportation, meals, or entertainment expenses were incurred or some expenses were reimbursed, then the taxpayer must complete Form 2106.
22. Explain the 3%/80% limitation for high-income taxpayers.
Answer:
Itemized deductions are reduced by the lesser of 3% of the excess of AGI over the applicable amount, or 80% of the itemized deductions otherwise allowable for the tax year. The 3%/80% rule does not apply to medical expenses, investment interest, casualty or theft losses, or gambling losses.
Multiple Choice
23. Itemized deductions are first reported on the:
a. Form 1040.
b. Schedule B
c. Form 2106
d. Schedule A
Answer: d
24. The majority of itemized deductions are:
a. Business expenses
b. Tax credits
c. Personal living expenses
d. None of the above
Answer: c
25. Generally, a taxpayer may deduct the cost of medical expenses for which of the following:
a. Marriage Counseling
b. Health club dues
c. Doctor prescribed birth control pills
d. Trips for general health improvement
Answer: c
26. The threshold amount for the deductibility of allowable medical expenses is:
a. 2.5% of AGI
b. 7.5% of AGI
c. 10% of taxable income
d. 15% of taxable income
Answer: b
27. During 2006 Sheniqua incurred and paid the following expenses:
Prescription drugs $ 470
Vitamins and over the counter cold remedies 130
Doctors and dentist visits 700
Health club fee 250
Cosmetic surgery 2,400
What is the total amount of medical expenses (before considering the limitation on AGI) that you would enter into the calculation of itemized deductions for Sheniqua’s 2006 income tax return?
a. $1,170
b. $1,300
c. $1,550
d. $3,950
Answer: a
28. To qualify for a medical expense deduction as your dependent, a person must be your dependent either at the time the medical services were provided or at
the time you paid the expenses. A person generally qualifies as your dependent for purposes of the medical expense deduction if:
a. The person would qualify as a dependent except for the amount of gross income
b. The person was a foreign student staying briefly at your home
c. The person is your sibling’s unmarried adult child
d. The person is the unrelated caregiver for your elderly parents
Answer: a
29. For 2006, Miguel, who is single and 45 years of age had calculated AGI of $40,000. During the year he incurred and paid the following medical costs:
Doctor and dentist fees $2,350
Prescription medicines 325
Medical care insurance premiums 380
Long term care insurance premiums 600
Hearing aid 150
What amount can Miguel take as a medical expense deduction (after the AGI limitation) for his 2006 tax return?
a. $3,805
b. $3,735
c. $805
d. $735
Answer: d
30. Which of the following types of taxes are not deductible on Schedule A in 2006?
a. Personal property taxes
b. Local real estate taxes
c. Sales taxes
d. All of the above
Answer: c
31. During 2006, Yvonne paid the following taxes related to her home:
Property taxes on residence (paid from escrow account) $1,800
State personal property tax on their automobile (based on value) 600
Property taxes on land held for long-term appreciation 300
What amount can the Yvonne deduct as property taxes in calculating itemized deductions for 2006?
a. $2,100
b. $2,700
c. $3,100
d. $3,700
Answer: b
32. What is the maximum amount of personal residence acquisition debt on which interest is fully deductible?
a. $1,000,000
b. $500,000
c. $250,000
d. $0
Answer: a
33. For 2006, the deduction by a taxpayer for investment interest is:
a. Not limited
b. Limited to the taxpayer’s net investment income for 2006
c. Limited to the investment interest paid in 2006
d. Limited to the taxpayer’s investment income for 2006
Answer: b
34. For 2006, Elizabeth, a single mother, reported the following amounts relating to her investments:
Investment income from interest $7,000
Investment expenses related to the production of interest 2,000
Interest expense on funds borrowed in 2005 to purchase land for investment 6,000
What is the maximum amount that Elizabeth can deduct in 2006 as investment interest expense?
a. $1,000
b. $5,000
c. $6,000
d. $7,000
Answer: b
35. Referring to previous question, what is the treatment for the interest expense that Elizabeth could not deduct in 2006?
a. It is lost
b. It cannot be used except as a carryback to previous years.
c. It can be carried forward and deducted in succeeding years
d. None of the above
Answer: c
36. Which of the following organizations qualify(ies) for deductible charitable contributions?
a. The local public library.
b. Salvation Army.
c. Churches.
d. All of the above.
Answer: d
37. Which of the following statements is not true regarding documentation
requirements for charitable contributions?
a. If the total deduction for all noncash contributions for the year is more than $500, Section A of Form 8283, Noncash Charitable Contributions, must be completed.
b. A noncash contribution of less than $250 must be supported by a receipt or other written acknowledgement from the charitable organization.
c. A contribution charged to a credit card is a noncash contribution for purposes of documentation requirements.
d. A deduction of more than $5,000 for one property item generally requires that a written appraisal be obtained and attached to the return
Answer: d
38. In 2006, the president of the United States declared a federal disaster due to brush fires in the Southwest. Lisa lives in that area and lost her home in the fires. What choice does she have regarding when she can claim the loss on her tax return?