RTRP Exam Review Webinar Program. Brought to you by: National Society of Accountants 1 (800) Deductions

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RTRP Exam Review Webinar Program Brought g to you y by: y

National Society of Accountants www.nsacct.org 1 (800) 966-6679 1

Deductions Presented by: John O. Everett, Ph.D., CPA and Cherie J. Hennig, Ph.D, CPA

National Society of Accountants May, 2012




Section A Deductions for Adjusted Gross Income


Topic 1 Expenses Related to Rents & Royalties




1A Deduction For & From AGI • Several Exam Questions – More than likely, will refer directly or indirectly to this distinction • Sec. 62 – The sole list of items deductible FOR adjusted gross income (AGI). Any deduction not listed here is by default from AGI. • No N G Guides id – Each E h category (for (f andd from) f ) has h a mixture of personal and business deductions


1B Sec. 212 Expenses • Sec. 212 – Allows 3 types of deductions for income-producing income producing activities: – Production of income expenses (e.g., rental utility) – Maintenance of income-producing property (repair of rental property) – Determining/litigating a tax liability (tax prep fee)

• Expenses Related to Rent & Royalty Income – O l Sec. Only S 212 expenses ddeductible d ibl for f AGI; AGI those relating to investments are from AGI • Question 1 6



Question 1 Which of the following expenses is not allowed as a deduction for adjusted gross income? A. advertising expense related to a rental duplex held for income-producing purposes B. subscription to investment newsletter for stocks & bonds bo ds held e d for o income-producing co e p oduc g pu purposes poses C. consulting fees related to oil royalty income D. all of the above are deductions for adjusted gross income 7

1C Rent & Royalty Expenses • Rental Concepts Tested on the Old EA Exam: – Allocating rental/personal usage (by floor space) – Converted personal property (use depreciation rules applicable at date of conversion) – Sec. 179 expensing (not available for rentals) – Repairs p ((ordinaryy maintenance)) vs. capital p expenditures (add value, extend life, or create a different use)

• Question 2, Question 3 8



Question 2 During the year, Dan had the following expenses for his rental house: 1. 2 2. 3. 4. 5. 6.

replaced a screen in the storm door replaced the heating system sowed grass seed in some bare spots on the lawn built a detached two-car garage installed a new dishwasher bought a welcome mat for the front stoop

Which of these items must be depreciated rather than deducted as an expense of his Schedule E? A. 1, 3, 4, and 5 B. 2, 4, 5, and 6 C. 2, 4, and 5 D. 3, 4, and 6 9

Question 3 Mae James rents half of her duplex and lives in the other half. During the current year, Mae incurred the following costs related l d to the h duplex: d l $1,000 $1 000 interest, i $2,000 $2 000 taxes, $500 repairs to the bathroom in the rental side, $900 repairs to the ceiling in the personal side, $300 to advertise the rental portion, and $600 for pest control services for the whole duplex. On Mae’s Schedule E, she will report rental expenses of: A B. C. D.

$ 800 $1,100 $2,600 $3,500 10



Topic 2 Tax Treatment of Alimony


*2A Requirements for Alimony • Alimony – Deducted FOR AGI by payor, income to payee (child support not includible/deductible) • Undesignated/Partial Payments – First child support • 4 Conditions for Alimony: – – – –

Cash payments pursuant to a written instrument No payments designated as “not alimony” S Spouses are not members b off the h same hhousehold h ld No liability for payment after death (either spouse)

• Question 4 12



Question 4 Which of the following items might be considered as alimony? A. child support payments B. non-cash payments C. premium paid under a divorce or separation agreement for life insurance to the extent that the other spouse owns the policy D. payments made for the 12-month period after the death of the recipient spouse 13

2B The Alimony Deduction • “Catchup” Child Care Pay – Never alimony • Payments in the Nature of Alimony – Qualify; includes mortgage and medical payments • Property Settlements – Tax rules are: – Are not alimony, since they are not in cash – No gain reported on transfers to spouse spo se – Carryover basis to recipient spouse

• Questions 5 and 6 14



Question 5 Todd and Susan divorced on September 1. As part of the divorce decree, beginning in September, Todd was to make payments off $2 $2,000 000 a month h ffor the h bbalance l off the h year to Susan’s doctor for recent medical expenses; child support payments of $500 per month, and $1,500 a month for the mortgage payment on a jointly-owned home. Susan and the children will continue to live in the home. What is the amount Todd can deduct as alimony for the calendar year? A. A B. C. D.

$16 000 $16,000 $11,000 $ 4,200 $ 9,600 15

Question 6 Under the terms of their divorce agreement executed in October, Keith transferred Corporation M stock to his former wife, if Karen, K as a property settlement. l At A the h time i off the h transfer, the stock had a basis to Keith of $20,000 and a fair market value of $50,000. What is the tax consequence of this transaction to Keith, and what is Karen’s basis in the Corporation M stock? A. B. C. D.

Keith has a gain of $30,000; Karen’s basis is $20,000 Keith has a gain of $30,000; Karen’s basis is $50,000 Keith has no gain or loss; Karen’s basis is $20,000 Keith has no gain or loss; Karen’s basis is $50,000




2C Alimony Recapture Rules • Recapture Rule – Prevents front-loading of payments apply only in 3rd year after divorce payments, • Recapture Amount – Reverse original Yr.1/Yr. 2 reporting in Year 3 for payor and payee • Death or Remarriage – Voids recapture • Year 2 Recapture =Yr. 2 – (Yr. 3 + $15,000) • Year 1 Recapture = Yr. Yr 1 – (Avg. (Avg Yr Yr.1 1 & Yr Yr.2 2* + $15,000) * Yr. 2 as corrected w/ recap. • Figure 1-1 17

Figure 1-1 Example – Alimony Recapture Rules Jack and Rita Null were divorced in 2011. Under the terms of the divorce decree, Jack will pay Rita the following amounts of alimony during the first three years of their divorce: 2011 ($85,000), ($85 000) 2012 ($60,000), ($60 000) and 2013 ($40,000). Jack paid and deducted $85,000 in 2011 and $60,000 in 2012, and Rita included the same amounts as income on her returns. The recaptures are computed as follows: • Year 2 = $60,000 – ($40,000 + $15,000) = $5,000 • Year 1 = $85,000 – {[($55,000 + $40,000) / 2] + $15,000} = $22,500 Note in the calculations that the Year 2 figure used in the Year 1 recapture computation was the “corrected” amount of $55,000 ($60,000 less the $5,000 recapture computed above). Thus, the total recapture is $27,500 ($5,000 + $22,500), income to Jack in Year 3 and deductible by Rita in Year 3. The $40,000 payment is treated normally.




Topic 3 Moving Expense Deductions


3A Moving Expense Tests • Two Tests for Deductible Moving Expenses – – Distance Di t – Commute C t to t workk would ld have h increased at least 50 miles if TP remained in old residence (or location, if no present job) – Work – TP must work in new location at least 39 weeks of 1st year (78 of first two if self-employed)

• Married Couple – Either spouse can meet either test • Question 7 20



Question 7 Mark was permanently transferred from his office in Virginia to another office in Washington, D.C. His office in Virginia is 10 miles from his home. For Mark to meet the distance test for moving expenses, how many miles must the office in Washington be from his current home? A. B B. C. D.

45 35 60 10 21

3B Moving Expense Deduction • Deductible Moving Expenses – All direct costs off moving i family, f il belongings, b l i andd cars • Auto Expense – Actual or optional $.19 per mile (before 7/1/11) or $.235 (after 6/30/11) • Lodging in route – Deductible (no meals) • Reimbursements R i b t – Reduce R d deduction, d d ti nott included in income unless item not deductible • Question 8 22



Question 8 Pat moved to start a new job and met the distance and time tests. Pat had the following moving expenses: • cost off packing, ki crating, i & transporting i h household h ld goods d – $1,200 $1 200 • lodging for travel between her old home and her new home – $550 • meals during the trip – $150 • $250 to break the lease on her old home What are the total moving expenses that can be deducted from total income to arrive at adjusted gross income? A $2,150 A. $2 150 B. $1,900 C. $1,750 D. $2,000 23

Topic 4 Individual Retirement Accounts (IRAs): Basic R Requirements i t 24



*4A IRAs – Qualification Requirements • Required – Earned comp., < age 70½ at year end • Spouses – Each has account (total compens. compens limit) • Contributions – Up to due date (no extension); owner cannot be trustee (bank or fiduciary is OK) • Investments in IRA – Not allowed in saving bonds or collectibles (but U.S. gold or silver coins are OK) • Rollovers – If w/d, redeposit w/i 60 days; no loans • Death – IRA included in estate, can only be rolled over by spouse, can combine with spouse, basis c/o • Question 9 25

Question 9 Which of the following would be an allowable investment for a traditional IRA? A. stamps which have been issued by the United States Postal Service B. an oil painting certified by an art expert as being an authentic original by a Dutch master artist C. one-ounce silver coins minted by the U.S. Treasury D. all of the above 26



*4B IRAs – Earned Compensation • “Earned Inc.” – Limit on IRA contribution/deduction • Does Not Include - Deferred comp, comp unearned sources (interest, dividend, etc.), or a limited partner’s share of income • Includes – Wages/salary/commissions, S/E income (less ½ SE tax & other retirement contributions), taxable alimony & separate maintenance payments y for earned income • S/E Loss – Does not offset salary limitation purposes • Question 10


Question 10 Which of the following is compensation for the purpose off contributions t ib ti to t individual i di id l retirement accounts? A. deferred compensation received B. foreign earned income excluded from income C. pension or annuity income D. taxable alimony and separate maintenance




*4C-1 IRAs & Pension Plans – Prohibited Transactions • Prohibited Transactions – Plan and D/Q Person: – – – –

Transfer T f income/assets i / t to t “disqualified” “di lifi d” person (see ( below) b l ) Fiduciary acting in its own self-interest Consideration to fiduciary from plan party Any acts between plan/disqualified Person (sell, lending)

• IRA Rule – If prohibited transaction occurs, taxpayer loses IRA status as of 1st day of year year, and account balance treated as distribution of cash (FMV of account) on 1st 29

*4C-2 IRAs & Pension Plans – Prohibited Transactions • Disqualified Person – Fiduciary, person servicing plan employer of plan employees, plan, employees controlled entity employer of plan employees, family member of above, controlled entity of above, off/director/10% SH/10% partner/highly comp. employee of above, 501(c) trust • Tax on Transaction – 15%, 15% 100% if not corrected within one year • Question 11 30



Question 11 Generally, which of the following is a prohibited transaction concerning your traditional IRA? A. withdraw funds for qualified higher education expenses B. pledge your IRA account as security for your mortgage C. withdraw funds for qualified medical expense D. withdraw funds to purchase your first home


Topic 5 IRAs - Contributions, Deductions & Penalties




*5A IRAs – Determining the Maximum Contribution & Deduction • Maximum Contribution – Lesser of $5,000 per spouse ($6,000 if 50 or older), or taxpayers’ combined earned income • Maximum Deduction – Dependent on other plan participation: • Neither Spouse Participates – Maximum $5,000/$6,000 each • Both Spouses Participates – Phase out $5,000/$6,000 proportionately for AGI between $56,000-$66,000 (S) or $90,000-$110,000 (MJ) • One Spouse Participates – If covered, same as both; if not covered, AGI phase-out over $169,000-$179,000 [$200 min.] • Figure 1-2 • Question 12 33

Figure 1-2(1) IRA Contributions & Deductions (1) Rob and Shelley are married taxpayers. Rob (age 32) earned $40,000 $40 000 and Shelley (age 31) earned $55,000; neither is covered by a qualified plan, and total AGI is $95,000 [Rob and Shelley may each contribute and deduct a maximum of $5,000 to his or her individual IRA, a total of $10,000]. (2) Same facts as (1) (1), except that Rob is 54 years old and Shelley is 49 [Rob’s maximum contribution and deduction increases to $6,000, Shelley’s maximum remains at $5,000]. 34



Figure 1-2(2) IRA Contributions & Deductions (3) Same facts as (1), except that Rob is covered by a qualified plan [contributions remain at $5,000 each, but Rob Rob’ss deduction is reduced to $3,750 ($5,000 maximum less 5/20’s of $5,000), as they are $5,000 into the $20,000 phase-out range above $90,000 AGI); Shelly’s deduction remains at $5,000]. (4) Same facts as (3), except that total AGI is $176,000 [contributions remain at $5,000 each; Rob gets no deduction (completely phased out), and Shelley’s deduction is reduced to $1,500 ($5,000 maximum less 7/10’s of $5,000), as they are $7,000 into the $10,000 phase-out range above $169,000 AGI]. ((5)) Same S ffacts as (1) (1), except that h Rob’s b’ earnedd compensation i was $7,000 $ 000 andd Shelley’s compensation was $2,000, and Rob elected to contribute $5,000 to an IRA [Rob’s contribution and deduction remains at $5,000, but Shelley’s contribution/deduction, if she chooses to make such a contribution, is limited to $4,000 ($9,000 total earned compensation less $5,000 contributed by Rob)].


Question 12 Lenny and Norma file a joint return for tax year 2011. Lenny is covered by a retirement plan, but Norma is not. Norma wishes t make to k a contribution t ib ti to t a traditional t diti l IRA IRA, andd her h earnings i alone are $1,500. The combined earnings on the joint return are $161,000 (the same as the modified AGI). Which of the following is correct? A. B. C. D.

Norma may make a nondeductible contribution of 2,000 Norma may make a deductible contribution of $5,000 Norma may not make any contribution Norma may make a deductible contribution of $3,000 and a nondeductible contribution of $2,000




*5B Roth IRAs • Roth IRA – No age limit, contribute up to $5,000/$6,000; nondeductible, but no tax on withdrawals after 5-year y pperiod; reduce $5,000/$6,000 by contributions to regular IRA • Phase-out – MJ($169,000-$179,000), S($107,000-$122,000) • Tax-Free Distributions – After 5 years if age 59½, disabled, or first-time home buying • Regular IRA – May be converted to Roth ($100,000 AGI limit no longer applies); recognize deferred income at conversion (f 2010 only, (for l spread d over two years, 2011 andd 2012) • Re-characterizations – Possible if trustee to trustee • Question 13


Question 13 Which of the following is correct regarding contributions to a Roth IRA? A. Contributions may be made regardless of age provided other requirements are met. B. Contributions may be deducted if you are within certain income limits. C Contributions may be deducted if you are not C. covered under a retirement plan. D. Contributions may not be deducted, but earnings are taxable when distributed. 38



5C Educational (Coverdell) IRA • Educational IRA – Designate as such, for education p of beneficiary y (child ( < 18)) expenses • Contributions - $2,000 maximum total per child, nondeductible; AGI phase-outs @$95,000/$190,000 • Amounts Spent – Not taxable if for qualified education expenses; any excess taxed @ regular rate + 10% q Withdrawal – Within 30 days y of beneficiaryy • Req. reaching age 30, or date of death if before • Exceptions – Special needs, military • Question 14 39

Question 14 Which of the following is correct regarding a C Coverdell d ll (education) ( d ti ) IRA? A. contributions are deductible B. contributions other than cash may be made C. contributions may be made until age 30 D the D. th annuall contribution t ib ti limit li it is i $2,000 $2 000 for f each child, no matter how many education IRAs are set up for that child 40



*5D IRA – Excess Contribution • 6% Excise Tax – Nondeductible penalty applies li to t excess contribution t ib ti nott withdrawn ithd by due date (including extensions); also applies to maximum required distribution that is not distributed • Penalty – Continues until excess is withdrawn • If Reasonable Error – Letter to IRS may work • Question 15 41

Question 15 Generally, the excess contribution to an IRA is subject to a tax. Which of the following is correct? A. You will not have to pay the 6% tax if you withdraw the excess contribution and any income earned on the excess contribution before the date your tax return for the year is due, including extension. B. The 6% tax is due on both the excess contributions and any income earned on the excess contribution. C. You will not have to ppay y the 6% tax if you y withdraw the excess contribution and the earnings on the excess contribution are less than 6%. D. You will not have to pay the 6% tax if you withdraw only the earnings on the excess contribution for the current year and subsequent years.




*5E-1 IRA Distributions • 10% Penalty – If distributed before age 59½, based on amount included in income; includes IRA “corrections” for excess contributions in earlier years • Exceptions – Death, disability, age 59½, annuity pay (age 55 & separated from service, continue for longer of 5 years or until age 59½), domestic relations order, deductible medical expenses expenses, IRS levy, levy higher education expenses, $10,000 first-time home expenses, IRS levy against qualified plan


*5E-2 IRA Distributions • Illegal Roth Conversion – Taxable, 10% and 6% penalties • 50% Tax on Failure to Distribute – On amounts required to be distributed at age 70½ • Minimum distributions - must begin no later than April 1st of the year following the year taxpayer turned age 70½ (or retirement date, if later) • Normal Distributions – Annuity rules, recover nondeductible contributions as an exclusion ratio • Rollovers – To or from IRA, 60-day period allowed to complete • Question 16




Question 16 Generally, you must begin receiving distributions from your traditional IRA no later than which of the following dates? A. Six months after your 70th birthday B. December 31 of the year in which you reach age 70½ C. April 1 of the year in which you reach age 70½ D. April 1 of the year following the year in which you reach age 70½ 45

Topic 6 Other Deductions for Adjusted Gross Income




6A Self-Employment (S/E) Tax and Health Insurance Deductions • S/E Tax Deduction – generally 50% of tax deductible for AGI (different % in 2010/2011) • S/E Health Insurance Premiums – 100% of premiums for S/E person and family deductible for AGI • Limits on S/E Insurance Deduction – – Limited to Schedule C earnings (net of Keogh deduction) – Disallowed Di ll d if S/E TP or spouse is i eligible li ibl to participate i i in i an employer-subsidized plan

• Question 17 47

Question 17 In regard to health insurance costs for self-employed individuals, all of the following are true except: A. a self-employed individual can deduct as an adjustment to income, up to 100% of the medical insurance premiums paid B. the self-employed health insurance deduction cannot exceed the net earnings from the business in which the insurance plan is established C. the insurance premiums paid in excess of the allowable selfemployed p y health insurance deduction are included with other medical expenses as an itemized deduction on Schedule A D. in a family health care plan, only the health insurance premiums allocable to the self-employed individual can be deducted as an adjustment to income




6B Student Loan Interest • Student Loan Interest – Deduct up to $2,500 for AGI, AGI phased out from $50,000-$65,000 $50 000 $65 000 for Single ($100,000-$130,000 for MJ) • Other Education Deductions – Up to $4,000 deductible for AGI for family post-secondary tuition, limited to AGI < $65,000 ($130,000 for MJ); scaled down to $2,000 $2 000 above these limits, then $0 above $80,000/$160,000) • Question 18 49

Question 18 Mr. Jones has a student loan for qualified higher education expenses p on which interest was due. The loan ppayments y were required from July 1, 2004 until December 31, 2011. The interest payments were $1,200 per year. How much may he deduct in arriving at adjusted gross income in 2011? A. B B. C. D.

$ 600 $1 000 $1,000 $1,200 $ -050



6C Health Savings Accounts (HSAs) • Health Savings Accounts With High Deductible Insurance ($1,200/$2,400) ($1 200/$2 400) – Make pre-tax pre tax contricontri butions of $3,050 ($6,150 families), and add $900 if age 55 or older; maximum out-of-pocket expenses are $5,950 ($11,900 families); exclude if used for medical expenses, excess taxed, plus 10% (if early) • Question 19


Question 19 A single individual may make a maximum d d tibl contribution deductible t ib ti (for (f adjusted dj t d gross income) i ) to a Health Savings Account in 2011 of A. $1,200 B. $2,400 C $3,050 C. $3 050 D. $5,950




6D Penalty for Early Withdrawals of Interest • Form 1099 – Includes full amount of interest,, separately states any early withdrawal penalty applied during the year • Reporting – Entire amount of interest is reported on Schedule B as income, penalty is a d d ti for deduction f AGI tto reflect fl t correctt nett amount • Question 20 53

Question 20 During the current year, Susan received $4,800 as interest income and also paid an early withdrawal penalty of $1,200 on a certificate ifi off ddeposit i she h hhad d at the h llocall bbank. k Whi Whichh off the h following is the correct way for Susan to report these items on her tax return? A. include $3,600 interest in gross income B. include $4,800 interest in gross income C include $4 C. $4,800 800 interest in gross income and deduct $1,200 as an itemized deduction D. include $4,800 interest in gross income and deduct $1,200 as an adjustment to income 54



6E Other Miscellaneous Deductions For Adjusted Gross Income (AGI) • D Deductions d ti for f AGI – Listed Li t d in i Sec. S 62 • Deductions from AGI – Any other allowable deductions not listed in Sec. 62 (Note – Any “covered” miscellaneous itemized deductions are subject j to the 2% AGI floor)) • Figure 1 – 3 (Study, study, study . . .) • Question 21 55

Figure 1-3(1) Most Common Deductions for AGI • • • • • • • • • • • • •

Losses from the sale or exchange of property Deductions related to rents and royalties R i Retirement contributions ib i off the h self-employed lf l d (Keogh (K h Plans/SIMPLE Pl /SIMPLE Plans) Pl ) Individual retirement account contributions (if allowed) Forfeiture penalty for premature withdrawal from savings Alimony (if deductible) Jury pay surrendered to employer Moving expenses Student loan interest ($2,500 maximum), educational supplies ($250 max.) One-half One half of any self-employment self employment tax paid 100% of any health insurance premiums paid by self-employed Qualified adoption expenses (if credit is not allowed) Health Savings Account (HSA) deduction ($3,050 single, $6,150 families)




Figure 1-3(2) Most Common Deductions from AGI • Personal and dependency exemption deductions ($3,700 per exemption) • Standard deduction (2011): $11,600 (MJ, SS), $8,500 (HH), $5,800 (S), or $5 800 (MS), $5,800 (MS) or Itemized Deductions, Deductions if larger • Itemized Deductions not Subject to the 2% of AGI Floor: – – – – – –

Medical expenses (7.5% of AGI floor) Qualified investment & personal interest expense (limited) State and local taxes Charitable contributions Personal casualty and theft losses Unrecovered investments in annuities at death

• Itemized Deductions Subject to the 2% of AGI Floor: – Investment expenses not related to rents and royalties – Tax return preparation and representation fees – Unreimbursed employee expenses, including: 50% of meals and entertainment, Travel and transportation expenses, Dues, subscriptions, and fees, specialized work clothing and tools, Education expenses, Home office expenses 57

Question 21 The following items are reported on Mr. and Mrs. Spice’s joint return: • net profit on Mrs. Spice’s Schedule C of $40,000 • Mr. Spice paid court-ordered alimony of $5,000 • self-employment tax of $6,120 on Mrs. Spice’s Schedule C Compute their adjusted gross income for the year. A. B. C. D.

, $31,940 $35,000 $28,800 $40,000




Topic 7 Itemized Deduction Medical Expenses


*7A Medical Expenses - Family • Deduction – Those of TP, spouse, dependent • Dependent D d – Ignore I gross income i & filing fili status tests • Special Rules: – – – –

Dependency – Deduct either treatment or payment Divorced – Either parent may claim child’s expenses Adopted Child – OK if incurred/paid after negotiations Multiple l i l Support – Only l claimant l i off exemption i may deduct expenses he or she paid

• Question 22 60



Question 22 During the year, Mr. and Mrs. Duhon paid the following expenses for their son, Joel: • • •

Medical insurance premiums Contact lenses Household help recommended by a doctor

$1 500 $1,500 $ 210 $2,220

Joel had gross income of $5,750. Because Joel had gross income of $5,750, the Duhons did NOT claim him as a dependent. How much of Joel’s medical expenses can Mr. and Mrs. Duhon include with their deductible medical expenses? A. B B. C. D.

$3,910 $1,710 $1 710 $1,500 $-0-


*7B Qualifying Medical Costs • Expense – Must be for specific disease/illness Obesity abortion, abortion birth control control, Medicare Part • Qualified – Obesity, B and long-term care premiums, stop smoking • Nonqualified – Over the counter drugs, cosmetic surgery (unless deformity), health club dues, meals • Decedent’s Medical Expenses – Qualify if paid within one year of death • Related R l t dT Travell – Transportation T t ti costs t (actual ( t l or optional ti l $.19 per mile Jan. 1-June 30, 2011 $.235 per mile July 1Dec. 31 2011), $50 per person/per night hotel • Question 23 62



Question 23 Which of the following expenses are not d d tibl as medical deductible di l expenses?? A. Insulin used for diabetes. B. Wig, purchased upon the advice of a physician for the mental health of a patient who has lost all of his/her hair from disease. C. Swimming lessons, recommended by a doctor for improvement of general health. D. Acupuncture used for migraines. 63

*7C Med. Capital Expenditure • If Not Increasing Value of Property – Deduct in full (e.g., (e g crutches, crutches wheelchairs, wheelchairs ramps ramps, doorway modifications) • If Increasing Value of Property – Deduct only to extent of not increasing the value of the property (e.g., elevator, swimming pool, etc.) • Maintenance Expense – Deduct as well • Decorative Work – Not deductible • Question 24 64



Question 24 Billy had bypass heart surgery in February. At the advice of his doctor, he had an elevator installed in his home so that he would not have to climb stairs. The costs associated with this capital p improvement p are as follows: • • • • •

Cost of elevator installed Increase in value of home due to elevator Cost of decorative lattice work over elevator Increase in value of home due to lattice work Maintenance and repair of elevator

$5,000 $2,500 $ 500 $ 0 $ 500

None of the expenses were covered by insurance. How much would qualify as deductible medical expenses expenses, BEFORE any limitation? A. B. C. D.

$3,000 $2,500 $3,500 $5,500


7D Medical Deduction Computation • Reimbursements – Reduce deduction (delay d d ti if expected deduction t d in i the th near future) f t ) • Tax Benefit Rule – Applies to reimbursement received in a later year (i.e., income only to extent of previous tax benefit of deduction) • 7.5% 7 5% of AGI Floor – Only amounts exceeding this floor are deductible • Question 25 66



Question 25 Chris flew to Chicago for surgery. He incurred the following costs in connection with the trip: • • • •

Round-trip airfare Lodging ($100 a night x 2 nights Restaurant Meals Hospital and Surgeon

$ 350 $ 200 $ 80 $5,000

What is Chris’ medical expense? A. B. C. D.

$5,550 $5,630 $5,000 $5,450


Topic 8 Itemized Deductions – Taxes




8A Real Property Taxes/Assessments • Real Property Taxes – State/local/foreign taxes are d d tibl if based deductible, b d on value l (ad ( d valorem) l ) • Personal Property Taxes – Deduct if based on value • Taxes on Realty – Deductible only by owner, always based on actual period of ownership (not payment) • If Buyer or Seller Pay Entire Year – Allocate the deduction, adjust selling price & basis for difference • Assessments – Not deductible if add to value (e.g., sidewalks) • Question 26 69

Question 26 Humberto purchased a new home on March 15, 2010, in a county that assesses real estate property taxes in the succeeding year (i.e., 2010 taxes assessed in 2011). At the closing on his new home,, Humberto received the followingg credits against g the purchase p price p of the home: • •

2009 real estate property taxes 2010 real estate property taxes pro-rated

$2,000 $ 420

In 2010, when the real estate property tax bill for 2009 came in, Humberto had to pay $2,000 total. The real estate property tax bill for 2010 rose to a total of $2,350 which he paid when he received it in 2011. What is the amount of Humberto’s deduction for real estate property taxes on his 2010/and 2011 income tax return A. B. C. D.

$2,220 $ 200 $ 0 $ 0

/ / / /

$2,350 $1,930 $1,930 $1,880 70



8B State & Local Sales Taxes and Income Taxes Paid • State & Local Income Taxes – Generally, deductible when h paid id (including (i l di withholdings) ithh ldi ) • Foreign Income Taxes – Deduct if no credit used • Reporting – Deduct income taxes on Schedule A, even if related to sole proprietorship business. • Sales Tax Option – TP may elect to deduct state & local sales taxes rather than state & local income t taxes. May M be b iincreasedd by b sales l taxes t paid id on home, h car, plane, boat, or building supplies • Question 27 71

Question 27 A taxpayer may elect to deduct the larger of state andd local l l income i taxes t or A. B. C. D.

state and local gasoline taxes state and local personal property taxes state and local real estate taxes state and local sales taxes 72



8C Other Personal Taxes Paid • Nondeductible Taxes – Federal taxes (income, excise, i estate t t or gift), ift) gasoline, li tobacco, t b utility tilit • Household Employee Payroll Taxes – Since it is a federal tax, it is not deductible • Tax Obligation – Must be that of the taxpayer, and not someone else else, in order to deduct • Question 28


Question 28 • • • • • • •

During the year, Anthony paid the following taxes: Real estate taxes on rental property he owns R l estate taxes on his Real hi own residence id Federal taxes State income taxes Local city income taxes Social security taxes for household help

$3,000 $4,500 $4 500 $4,000 $1,500 $ 500 $ 500

What amount can Anthony deduct as an itemized deduction on his tax return? A. B. C. D.

$6,500 $9,500 $10,000 $14,000




Topic 9 Itemized Deductions – Interest Expense


9A Requirements for Interest Expense • Obligation – Must be that of the taxpayer’s • Personal Consumer Interest – Not deductible • If Related to Tax-exempt Income – Not deductible (i.e., loan to purchase state bonds) • Timing of deduction – If cash basis, must be b th incurred both i d andd paid id • Reporting – Schedule C if business, Schedule A if personal or investment interest 76



9B Investment Interest Expense • Interest Expense on Investments – Deduction is limited to net investment income (interest/royalties/ short short-term term gains) • Nondeductible Amounts – Excess carry over • Long-Term Capital Gains & Dividends – Are not treated as investment income unless TP elects to tax such amounts taxed at ordinary rates (and not 15%) • Investment Expenses – Most are miscellaneous itemized d d ti deductions subject bj t tto 2% AGI floor; fl deduction d d ti is i lesser l off (1) actual expenses or (2) net miscellaneous itemized deduction total • Question 29 77

Question 29 How much of the following interest expense is deductible on Schedule A, before limitations? The taxpayer is reporting $1,500 in investment income. • $1,200 interest paid on loan used to purchase a vacant lot for investment. • $750 interest paid on a qualifying student loan. • $2,700 credit card interest on an advance used to make a down payment on a new home. • $625 interest on a loan used to invest in tax-free bonds. A. B. C. D.

$1,200 $1,950 $4,650 $3,900




*9C-1 Acquisition and Home Equity Interest Expense • Deductible Residential Interest Expense p – – Qualified Acquisition Indebtedness – Interest on first $1 million of loans secured by home (two homes qualify) and spent on home – Home Equity Indebtedness – Interest on first $100,000 of loans secured by home (two home qualify) but NOT spent on home; limited to (FMV of property – acquisition debt)


*9C-2 Acquisition and Home Equity Interest Expense • Points – On primary residence deductible (even if seller pays) • Second Residence & Refinancing Points – Amortize over life of new loan • Prepayment Penalties – Deduct unless clearly a service i or administrative d i i i charge h • Question 30 80



Question 30 Earl took out a mortgage on his home for $250,000 in 1996. He files as single taxpayer. In April, when the home had a fair market value of $430,000, Earl took out a home equity loan for $140,000. He used the proceeds as follows: • $90,000 for home improvements • $30,000 for payment of credit card debt • $20,000 for purchase of securities which produce tax-free income. How muchh off th H the $140,000 $140 000 loan l produces d d d tibl mortgage deductible t interest? i t t? A. $ -0B. $ 90,000 C. $120,000 D. $140,000 81

Topic 10 Itemized Deductions – Charitable Contributions




*10A-1 Qualified Charitable Organizations & Contributions • Deductible – Cash, Cash property, property & credit card to listed organizations (but not needy individuals) • Charity – May be public (public purposes) or private (limited purpose) • Value of Services Provided – Not deductible • Out-of-Pocket Expenses – Deductible; optional $.14 per mile for auto 83

*10A-2 Qualified Charitable Organizations & Contributions • Raffle Tickets, Charitable Purchases – Deduct excess over FMV of property/services rec’d. • Student Sponsored by Charity – Deduct $50 per month if living with the TP • Guarantees of Rights to Purchase Tickets – For athletic hl i events, deduct d d only l 80% off suchh donation • Question 31 84



Question 31 Mr. U is actively involved in church activities in his community. During the current year, he incurred the following church church-related related expenses: • Cash contributed to the church $2,000 • Round-trip mileage to attend church services (400 miles x .14) $ 56 • Round-trip mileage to do church volunteer work (500 miles x .14) $ 70 • Fair market value of used clothing given to church mission $ 500 • Raffle tickets purchased from the church $ 200 • Value of time and services contributed to the church $ 400 Mr. U’s adjusted gross income is $25,000 and he itemizes his deductions on his tax return. What is his charitable contribution deduction?

A. B. C. D.

$2,500 $2,570 $2,770 $3,170 85

10B Contributions of Cash • Overall Limit – 50% of AGI for both public andd private i t charities h iti combined bi d • Public Limit – 50% of AGI (deduct first) • Private Limit – 30% of AGI (deduct last) • 5-Year Carryover – Of unused contributions in eachh category t (deducted (d d t d only l after ft currentt year contributions are considered)




*10C Limits on Contributions of Property • Ordinary Income Property (if Sold) – Limited to (FMV – Gain taxed if property were sold at FMV) • Capital Gains Property (if Sold) – FMV of property, limited to 30% of AGI (Optionally, elect to deduct FMV – gain taxed if sold; raises AGI limit to 50%) • 50% Method – Req. for private donations of tangible personalty not used in tax-exempt function of charity • 30% Method – Must reduce 50% overall limit by total $ FMV contributed, and not just the 30% limit • Question 32 87

Question 32 Jerry’s adjusted gross income for the year is $40,000. How much of the following contributions (after limitations) can he deduct on Schedule A? • $1,000 paid at a charity auction for a week at a fishing resort. The trip is valued at $1,000. • $500 to the local Chamber of Commerce. • Land adjacent to his church for use as a parking lot. The fair market value of the land is $35,000. Jerry paid $20,000 for the land. He doesn’t elect to reduce the fair market value to qualify for a different AGI limit. A. A B. C. D.

$20,000 $20 000 $12,000 $10,500 $ 8,000




*10D Substantiation of Contributions • Substantiation – Required by earlier of (1) due date of return or (2) date filed • Cash/Prop < $75 – Written statement from charity • Cash < $250 Each – Checks, receipts, other • Cash => $250 Each - Written acknowledgement • Property < $250 – Written statement • Property =>$250 < $500 – Written acknowledgement • Property > $,5000 – Qualified Appraisal (Form 8283) • Question 33 89

Question 33 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 deduction of more than $1,000 C. $1 000 for one property item generally requires that a written appraisal be obtained and attached to the return. D. A contribution charged to a credit card is not a noncash contribution for purposes of documentation requirements. 90



Topic 11 Casualty & Theft Losses


11A Qualifying Casualties & Thefts • Casualty – Fire, storm, shipwreck or other sudden g g destruction not due to TP negligence • Theft – Items actually stolen, and not just lost • Loss on Deposits – Report as either (1) a casualty loss, (2) ordinary loss, or (3) nonbusiness bad debt • Personal Casualty Loss – May also be part of a net operating loss, providing NOL carryover benefit • Related Incidental Expenses – Not part of casualty • Temporary Living Expenses – Taxable, but can be reduced by any excess living expenses (> normal) • Question 34 92



Question 34 A deductible loss would result from which of the following: A. Valuable sound equipment stolen from your home by unknown persons. B. Damage to your home caused by termites over an extended period of time. C. Damage to your automobile caused by the willful negligence of a friend who was driving the auto D. A valuable piece of art destroyed by your household pet.


*11B Determining Casualty or Theft Loss Deductions • Initial Deduction – Lesser of (1) cost or (2) decrease in FMV of property (could be repairs) • Insurance – Reduces actual or potential loss • Personal Loss Floors - $100 per casualty/theft, and 10% AGI on total personal C&T loss • Business Losses – No floors, and if completely d destroyed, d deduct d d adjusted dj d basis b i off property • Reporting– Business (for AGI), Personal (from) • Question 35 94



Question 35 A flood damaged a personal auto owned by Mr. and Mrs. Montez. The area of the flood was a federally declared disaster area. Based on the following facts, what is the amount the Montez’ Montez casualty loss deduction for the year (assume an election was NOT made to file an amended return for the prior year)? • • • • • •

Fair market value before the flood Fair market value after the flood Cost basis Insurance proceeds Replacement thru disaster relief Adj t d gross income Adjusted i for f the th year A. B. C. D.

$ 7,000 $ 1,300 $ 9,500 $ 2,000 $ 1,100 $18 000 $18,000

$ 700 $1,800 $3,600 $4,500 95

11C Reporting Casualty and Theft Losses • • • •

Form 4684 – Used for both bus. & personal Casualties – Deduct in year of destruction Thefts – Deduct in year of discovery Casualty in Federally Declared Disaster Area – May elect to deduct on prior-year return • Insurance – Reduce loss for any insurance expected in the next year (even if refused) • Question 36 96



Question 36 A calendar year taxpayer’s home was destroyed by flood in 2011 and was located in a town declared a federal disaster area. A casualty loss of $10,000 was figured under the usual rules. On what return can the casualty loss be claimed? A. B B. C. D.

Only on the 2011 return. O l on the Only th 2010 return. t On either the 2010 or the 2011 return. Split the loss between 2010 and 2011 97

Topic 12 Miscellaneous Itemized – Employee Expenses




*12A-1 Meals & Entertainment Expenses • Deductible Entertainment – Includes: – Di Directly tl Related R l t d (bus. (b di discussion i during d i entertain.) t t i ) – Associated With (bus. discussion immediately before or immediately after entertainment)

• Tickets (report as entertainment if TP present, either as gift or entertainment if TP is not present) • 50% Disallowance – On M&E to ultimate payor • 20% Disallowance – M&E of transportation carriers


*12A-2 Meals & Entertainment Expenses • Entertainment Facilities – Maintenance cost not ded. • Country Club Memberships – Not deductible, but any direct costs incurred at facility (e.g., lunch) may be • Gifts - $25 limit per donee per year ($400/$1,600 service award) value) luxury skyboxes • Other Limits – Tickets (face value), (limited to # seats x highest non-box seat price) • Question 37 100



Question 37 Mr. Banks incurred the following unreimbursed business expenses for which he has adequate proof for the amounts and purpose. • Business meals $2,000 • Business entertainment $1,000 • Business gifts (10 gifts at $30 each to 10 different people) $ 300 Based on the above, what is the amount Banks can deduct BEFORE the percentage of adjusted gross income limitation? A. A B. C. D.

$1,625 $1 625 $1,650 $1,750 $2,650


*12B-1 Transportation and Auto Expenses • Deductible Commuting Costs – Office to client, between two jobs j • Incremental Costs – For transporting tools/equipment are deductible, including home to office • Auto – Deduct larger of actual or standard mileage • Actual Costs – All actual operating costs (gas, oil, insurance, depreciation), prorate for business usage Std Mileage Rate - $.51 $ 51 (January 11-June June 30) or $$.555 555 • Std. (July 1-December 31) per business mile in 2011; method not allowed on leased, for hire, or simultaneous use autos 102



*12B-2 Transportation and Auto Expenses • Actual Costs & Accelerated Depreciation – May not switch to Standard Mileage Method • Std. Mileage – If switch to actual, use straight-line depreciation • Parking & Fees – If business, add to either method • Transportation for Travel Expenses – Deductible only if TP is i “away “ from f home h on business” b i ” (see ( below) b l ) • Question 38


Question 38 Dan got a new job which requires him to extensively use his car for business purposes.. Dan’s records reflect he incurred the following expenses in 2011: • Gasoline and oil $3,100 • Repairs on auto $ 850 • Business parking and tolls $ 200 • Depreciation $2,200 • Insurance $ 795 • Licenses, tags, etc. $ 100 • Total $7,245 • Business Miles Method 24,000 @ $.51 = $12,240 What is the MAXIMUM deduction that Dan is allowed for the business use of his car? A. B. C. D.

$7,245 $12,240 $12,440 $12,540 104



*12C Travel Expenses of an Employee or Self-Employed • Travel Expenses – Includes transportation, meals, lodging and any incidentals while “away lodging, away from home” home on business • Tax Home – Workplace (“post of duty”), determined by time spent, activity, & total income; may be personal residence if established as business • Temporary Location – In travel status unless (1) more than h one year, or (2) indefinite; i d fi i in i both b h cases, tax home is presumed to have moved to new location • Question 39 105

Question 39 Samuel, a civil engineer, drives his own vehicle to various locations to inspect bridges for safety standard requirements. His employer reimburses Samuel $400 each month for various business expenses p and does not expect p Samuel to provide p proof p of his expenses. His employer included this $4,800 reimbursement in Samuel’s W-2 as part of his wages. Samuel incurred $3,000 in transportation expense, $1,000 in parking and tolls expense, $1,800 in car repairs expense, and $600 for expenses while attending a professional association convention. Assume Samuel uses the vehicle for business purposes only and that he maintains adequate documentation. What amount is Samuel entitled to deduct on his Schedule A for Itemized Deductions? A. B. C. D.

$6,400 of expenses subject to the 2% of adjusted basis gross income limitation limitation. $1,600, the difference between his expenditures and what he was reimbursed. $0 since his employer follows non-accountable plan. $4,800 since his employer follows non-accountable plan.




Topic 13 Miscellaneous Itemized Other Employment Expenses 107

*13A-1 Reimbursed Employee Expenses • Reimbursement – Reduces deduction, and 50% M&E limit li it applies li to t payor (e.g., ( employer) l ) • Expense > Reimbursement – Excess reported as miscellaneous itemized (2%) by employees (initially on Form 2106) • Reimbursement > Expense – Excess is income • Documentation – Amount, time, place, and purpose of expenditure 108



13A-2 Reimbursed Employee Expenses • Accountable Plan – Employee omits expense andd reimbursement i b t from f return t if: if – provides documentation to employer, and – returns unused amounts to employer

• Nonaccountable Plan – Reimbursement in gross income, income expenses are miscellaneous itemized deductions (2%) • Question 40 109

Question 40 Which of the following is NOT true for an employer’s accountable plan for reimbursement of employee travel, entertainment, gift care expenses? A A.


C. D.

If the h plan l calls ll for f actuall expense reimbursement i b but b excess reimbursement i b paid to an employee has been returned, then the employer must include the excess amount as wages on Form W-2, and the employee may deduct the excess reimbursement on Form 2106. If the plan calls for a per diem allowance amount in excess of the federal rate but the employee adequately accounts for the expenses incurred only up to the federal rate and does not return excess reimbursements, then the employer must include the excess amount over the federal rates as taxable income on Form W2, and the amount up to the federal rate in box 13, Form W-2 (code L). If the plan calls for actual expense reimbursement, adequate accounting is made and the excess returned, then no amount is reported as taxable income on Form W-2 and no amount is reported on Form 2106. If the plan calls for a per diem allowance up to federal rate and the employee adequately accounts for the expenses incurred and returns any excess, then no amount is included in Form W-2. To deduct excess expenses incurred, the employee must report on Form 2106 net reimbursements received (net of the excess reimbursements that were returned) and expenses claimed. 110



*13B Education Expenses • Deductible – If (1) improves skills req. on present job q to retain ppresent jjob or ((2)) meets minimum req. • Nondeductible – If (1) meet minimum req. for job, or (2) qualifies TP for a new job • Travel – Deductible only if location essential • Employee Reimbursement – Reduces deduction (also reduce for educational assistance pay) Exp – Books/tuition/fees, Books/tuition/fees transportation transportation, • Qualified Exp. and 50% of meals • Purely Recreational Courses – Do not qualify • Question 41 111

Question 41 During the year, Pare, a secondary school teacher, incurred the following educational expenses while attending two classes at the local college to become certified as a guidance counselor: • Travel from place of work to class at applicable rate $ 212 • Travel from college classes to home $ 148 • Tuition $1,350 • Books and fees $ 285 • Meals between work and class $ 300 Pare’s adjusted gross income is $42,000. What can Pare deduct as educational expenses?? A. B. C. D.

$1,007 $1,035 $1,157 $1,455 112



13C Miscellaneous Employee Expenses • Unreimbursed Employee Expenses – Reported as ( ) miscellaneous itemized deductions (2%) • Job-hunting Expenses – Deduct only if position sought is in taxpayer’s current trade or business • Other Possible Employee Deductions – – Unreimbursed dues, fees, professional subscriptions – Work clothing not adaptable to ordinary wear – Tools and equipment q p required q for job j

• Home Office & Home Computers – Deduction seldom allowed for employees (later discussion) • Question 42 113

Question 42 For the year, Mr. G, a construction worker, had adjusted gross income of $20,000. He incurred the following employment-related and investment-related expenses. • • • • • • •

Safety shoes Union initiation fees Union dues Life insurance Jeans and flannel shirts used for work Management fees on taxable income producing investments Legal expenses for drafting a will

$ 100 $2,000 $ 300 $ 800 $ 200 $1,200 $ 100

He was not reimbursed for any of the employment-related expenses. What is the amount of his miscellaneous expense deduction after any limitations? A. B. C. D.

$3,200 $3,400 $3,600 $4,600 114



Topic 14 Other Miscellaneous Itemized Deductions


14A Other Miscellaneous Deductions Not Subject to 2% Floor • Some Misc. Deductions – Escape p 2% floor • Examples of Other Itemized Deductions – – Impairment-related work expense – Deductions against Income in Respect of Decedent – Unrecovered annuity or pension costs of decedent – Gambling losses of amateur, to extent of winnings – Limited expenses of certain performing artists

• Question 43 116



Question 43 Which of the following is NOT subject to the 2% adjusted gross income limitation on miscellaneous deductions on Schedule A? A. Home office expense. B. Federal estate taxes on income in respect of a d d t decedent. C. Trade association dues. D. Job hunting expenses. 117

*14B Miscellaneous Itemized Deductions Subject to 2% of AGI Floor • Most Misc. Itemized - Subject to 2% Floor: – Investment expenses for other than rents/royalties – Allocated investment fees of nonpublic mutual funds (public funds net these on Form 1099-DIV) – Tax return preparation and litigation fees – Legal fees related specifically to tax advice – Certain hobby expenses (later discussion)

• Nondeductible – Campaign contributions, lobbying, fines & penalties, check writing fees, accreditation costs, costs of attending stockholder meetings • Question 44 118



Question 44 Which of the following are miscellaneous itemized deductions subject to the 2% adjusted gross income limitation? A. Federal estate tax on income in respect of a decedent. B. Gambling losses up to the amount of gambling winnings. g C. Casualty and theft losses from income-producing property. D. Payment for preparation of federal income tax return. 119

14C Applying the 2% of AGI Floor to Misc. Itemized Deductions • Total “Covered” Covered Misc. Misc Itemized – Reduce by 2% of reported adjusted gross income • Note – Read question carefully to determine whether or not question requires reduction to be applied • Question 45




Question 45 Jack had the following income for the year: $59,800 in wages; $200 in interest; $10,000 in gambling winnings; $5,000 in short-term capital gains. Jack filed a Schedule A, Itemized Deductions, for the year. While preparing th t schedule, that h d l Jack J k listed li t d the th following f ll i deduction d d ti items it he h had h d incurred: i d – – – – – –

$2,500 in medical expenses. $8,000 or mortgage interest paid. $2,000 in real estate taxes. $1,600 in state taxes. $12,000 in gambling losses. $3,400 in employee business expenses.

What is the total amount of Jack’s Schedule A itemized deductions? A. B. C. D.

$27,500 $25,000 $23,500 $21,100 121

Answers – Questions for Review 1. B

11. B

21. A

31. B

41. C

2 C 2.

12 B 12.

22 B 22.

32 B 32.

42 A 42.

3. C

13. A

23. C

33. C

43. B

4. C

14. D

24. A

34. A

44. D

5. B

15. A

25. D

35. A

45. C

6. C

16. D

26. C

36. C

7 C 7.

17 D 17.

27 D 27.

37 C 37.

8. C

18. C

28. A

38. C

9. C

19. C

29. A

39. A

10. D

20. D

30. C

40. A 122