Test bank taxation of individuals and business entities 2015 6e by brian c spilker chap011

Chapter 11 Investments True / False Questions Generally, interest income is taxed at preferential capital gains rates and dividend income is taxed at ordinary rates True False Interest earned on U.S savings bonds is interest received at sale or maturity but must be taxed annually True False An investment's time horizon does not affect after-tax rates of return on investments taxed annually True False When a taxable bond is issued at a premium, the taxpayer must calculate and apply the yearly amortization amount to reduce a portion of the actual interest payments that taxpayers include in gross income True False Qualified dividends are always taxed at a 15 percent preferential rate True False The capital gains (losses) netting process for taxpayers without 25 or 28 percent capital gains requires them to (1) net short-term and long-term gains, (2) net shortterm and long-term losses, and (3) net the outcome to yield a final gain or loss to place on the tax return True False Two advantages of investing in capital assets are (1) gains are generally deferred and (2) gains are generally taxed at preferential rates True False Dave and Jane file a joint return They sell a capital asset at a $150,000 loss Even though they have no capital gains, $6,000 of the loss can still be deducted in the current year True False 11-1 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Unrecaptured §1250 gain is taxed at the 28 percent preferential capital gains rate True False 10 Losses associated with personal-use assets, sales to related parties, and wash sales are not currently deductible True False 11 Capital loss carryovers for individuals are carried forward indefinitely True False 12 Investors must consider complicit taxes as well as explicit taxes in order to make correct investment choices True False 13 All life insurance proceeds given to the beneficiary at the time of death of the insured are excluded from gross income True False 14 §529 plans are limited to a yearly contribution of $2,000 for each beneficiary and can only be used to pay for qualified educational costs incurred from kindergarten through 12th grade True False 15 With tax-exempt investment income, an investor's before-tax rate of return is greater than her after-tax rate of return True False 16 High-marginal rate taxpayers generally prefer municipal bonds and low-marginal rate taxpayers generally prefer taxable corporate bonds True False 17 Nondeductible investment expenses (other than investment interest expenses) are carried forward indefinitely True False 18 Taxpayers may make an election to include long-term capital gains and qualified dividends in net investment income and deduct more investment interest expense currently if they are willing to subject these sources of income to ordinary tax rates True False 19 Investment expenses and investment interest expense are for AGI deductions True False 11-2 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 20 When electing to include long-term capital gains and qualified dividends in net investment income, taxpayers must include all long-term capital gains and dividends recognized for that year True False 21 The investment interest expense deduction is limited to the amount of net investment income for the year True False 22 Generally, losses from rental activities are considered to be active losses True False 23 Passive losses that exceed passive income are deferred until the taxpayer generates passive income to offset these passive losses True False 24 A loss from a passive activity is fully deductible as long as the taxpayer has sufficient tax basis in the activity True False 25 A passive activity is any activity that involves a trade or business or rental activity in which the taxpayer does not materially participate True False 26 To qualify under the passive activity rental real estate exception, the taxpayer must (1) own at least 15 percent of the property and (2) participate in the process of making management decisions True False Multiple Choice Questions 11-3 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 27 If Jim invested $100,000 in an annual-dividend paying stock today with a percent return, what investment time period will give Jim the greatest after-tax return? A year B years C 10 years D 20 years E All yield the same after-tax return 28 Which of the following types of interest income is not taxed as it is earned? A interest from savings accounts B original issue discounts on corporate bonds C accrued market discount on bonds D interest from money market accounts E All of these 29 Nontax factor(s) investors should consider when choosing between investments include: A before-tax rates of return B after-tax rates of return C liquidity needs D before-tax rates of return and after-tax rates of return E before-tax rates of return and liquidity needs 11-4 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 30 What rate should be used when calculating the after-tax future value of investments with a constant rate of return that is taxed annually? A annual before-tax rate of return B annual after-tax rate of return C marginal tax rate D preferential tax rate E average tax rate 31 If Tom invests $60,000 in a taxable corporate bond that provides a percent beforetax return, how much will Tom's investment be worth in either or 20 years from now when the bond matures? Assume Tom's marginal tax rate is 35 percent A $88,647; $159,198 B $92,782; $178,414 C $79,621; $121,716 D $77,495; $113,750 E None of these 32 One primary difference between corporate and U.S Treasury bonds is: A Treasury bonds always pay interest periodically B Corporate bonds always pay interest periodically C Interest from Treasury bonds is exempt from federal taxation D Interest from corporate bonds is exempt from state taxation E None of these 11-5 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 33 The amount of interest income a taxpayer recognizes when he redeems a U.S savings bond is: A the excess of the taxpayer's basis in the bonds over the bond proceeds B the bond proceeds C the excess of the bond proceeds over the taxpayer's basis in the bonds D the taxpayer's basis in the bonds E None of these 34 Which of the following is not a tax advantage of a Series EE Saving Bond? A taxes are paid as the original issue discount on the bond is amortized B interest earned is exempt from state taxation C taxes are deferred until the bond is cashed in at maturity D interest is exempt from federal taxation when used for qualifying educational expenses E None of these 35 When a bond is purchased in the secondary bond market at a discount, the amount of discount treated as interest income when the bond is sold prior to maturity is the: A market premium B market discount C accrued market premium D accrued market discount E None of these 11-6 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 36 If Adam invested $25,000 in a stock paying annual dividends equal to 5% of his investment, what would the value of his investment be 10 years from now assuming that he reinvested his after-tax dividends each year? Assume Adam's marginal ordinary tax rate is 15% A $26,94 B $40,72 C $37,90 D $101,13 E None of these 37 When selling stocks, which method of calculating basis provides the greatest opportunity for minimizing gains or increasing losses? A LIFO B FIFO C Weighted average D Specific identification E None of these 38 Long-term capital gains can be taxed at a maximum rate of: A 20 percent B 25 percent C 28 percent D Both 20 percent and 28 percent E All of these 11-7 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 39 Cory recently sold his qualified small business stock (acquired in 2014) for $90,000 after holding it for ten years His basis in the stock is $40,000 Assuming his marginal tax rate is 35 percent, how much tax will he owe on the sale? A $3,75 B $7,00 C $7,50 D $14,00 E None of these 40 In X8, Erin had the following capital gains (losses) from the sale of her investments: $2,000 LTCG, $25,000 STCG, ($9,000) LTCL, and ($15,000) STCL What is the amount and nature of Erin's capital gains and losses? A $3,000 net short-term capital gain B $3,000 net long-term capital loss C $4,000 net short-term capital gain D $4,000 net long-term capital loss E None of these 41 The netting process for capital gains (losses) with 0/15/20 percent, 25 percent, and 28 percent capital assets helps maximize the tax benefit of: A current year net loss in the 25 percent rate group B net short-term capital losses C long-term capital loss carryovers D current year net loss in the 25 percent rate group and long-term capital loss carryovers E net short-term capital losses and long-term capital loss carryovers 11-8 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 42 When the wash sale rules apply, the realized loss is: A recognized at time of sale B not recognized at time of sale and does not affect basis of newly acquired stock C recognized at time of sale and added to basis of the newly acquired stock D not recognized at time of sale and added to basis of the newly acquired stock E not recognized at time of sale and subtracted from the basis of the newly acquired stock 43 The maximum amount of net capital losses individuals may deduct against their ordinary income per year is: A $3,00 B $5,00 C Zero, losses are not deductible D There is no maximum All losses are allowed to be deducted E None of these 44 In the current year, Norris, an individual, has $50,000 of ordinary income, a Net Short Term Capital Loss (NSTCL) of $10,000 and a Net Long Term Capital Gain (NLTCG) of $2,800 From his capital gains and losses, Norris reports: A an offset against ordinary income of $10,000 B an offset against ordinary income of $3,000 and a NSTCL carryforward of $7,000 C an offset against ordinary income of $2,800 and a NSTCL carryforward of $7,200 D an offset against ordinary income of $3,000 and a NSTCL carryforward of $7,200 E an offset against ordinary income of $3,000 and a NSTCL carryforward of $4,200 11-9 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 45 Ms Fresh bought 1,000 shares of Ibis Corporation stock for $5,000 on January 15, 2012 On December 31, 2014 she sold all 1,000 shares of her Ibis stock for $4,500 Based on a hot tip from her friend, she bought 1,000 shares of Ibis stock on January 23, 2015 for $3,000 What is Ms Fresh's recognized loss on her 2014 sale and what is her basis in her 1,000 shares purchased in 2015? A $-0- LTCL and $3,500 basis B $200 LTCL and $3,300 basis C $300 LTCL and $3,200 basis D $400 LTCL and $3,100 basis E $500 LTCL and $3,000 basis 46 Kevin bought 200 shares of Intel stock on January 1, 2014 for $50 per share with a brokerage fee of $100 Then, Kevin sells all 200 shares for $75 per share on December 12, 2014 The brokerage fee on the sale was $150 What is the amount of the gain/loss Kevin must report on his 2014 tax return? A $4,50 B $4,75 C $5,00 D $5,25 E None of these 47 If an individual taxpayer's marginal tax rate is 35 percent and he holds the following assets for more than one year, which gain will be taxed at the highest rate at the time of sale? A gain from investment land B gain from personal-use property C gain from a coin collection D gain from the sale of qualified small business stock held for years E gain attributable to tax depreciation taken on real property 11-10 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 86 Scott Bean is a computer programmer and incurred the following transactions last year What is the Net Short-Term Capital Gain/Loss reported on the 2014 Schedule D? What is the Net Long-Term Capital Gain/Loss reported on the 2014 Schedule D? What amount of capital gain is subject to the preferential capital gains rate? $1,500 net short-term capital loss is reported on Schedule D, $9,000 net long-term capital gain is reported on Schedule D, and $7,500 of net capital gain is subject to the preferential capital gains rates Feedback: See calculations below: 11-74 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education AACSB: Analytic AICPA: BB Critical Thinking Blooms: Analyze Learning Objective: 11-02 Compute the tax consequences associated with the disposition of capital assets; including the netting process for calculating gains and losses Level of Difficulty: Medium Topic: Portfolio income: Capital gains and losses 87 Mr and Mrs Smith purchased 100 shares of stock for $45 per share on June 30, 20X6 On March 30, 20X8, the Smith family decides to sell these shares for $30 generating a loss of $15 per share On April 15, 20X8, the Smith family realized they made a mistake and repurchased 100 shares for $35 per share When will the Smith family receive a tax benefit for the loss on the March 30, 20X8 sale? The Smith family will have a ($1,500) long-term capital loss They had held the original stock for over a year; thus, the loss would be categorized as long-term However, the loss cannot be deducted on the 20X8 tax return The wash sale rules disallow the deduction because the Smith family sold and purchased similar stock in the same company within 30 days of selling the original shares However, the loss is added to the basis of the newly acquired stock Thus, the basis of the new stock is $5,000 or $3,500 (100 shares × $35) plus $1,500 (the disallowed loss) AACSB: Analytic AICPA: BB Critical Thinking 11-75 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Blooms: Analyze Learning Objective: 11-02 Compute the tax consequences associated with the disposition of capital assets; including the netting process for calculating gains and losses Level of Difficulty: Medium Topic: Portfolio income: Capital gains and losses 88 What is the tax treatment for qualified small business stock acquired in 2014 and held for more than five years and what is the tax treatment if held for less than five years? Qualified business stock is considered a capital asset Thus, preferential treatment is provided under certain circumstances If stock acquired in 2014 is held by an investor for more than five years, one-half of the gain will be excluded from income; the remaining gain will be taxed at a maximum 28 percent If the stock has been held by an investor for less than five years, the entire gain is taxed; however, the gain will be taxed at a maximum 0/15/20% rate AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Analyze Blooms: Understand Learning Objective: 11-02 Compute the tax consequences associated with the disposition of capital assets; including the netting process for calculating gains and losses Level of Difficulty: Medium Topic: Portfolio income: Capital gains and losses 89 When considering tax-favored investments, taxpayers must not only look at explicit taxes but also implicit taxes to properly compare them with other less favorably taxed investments Generally speaking, how explicit and implicit taxes affect the investment decisions of high and low marginal rate taxpayers? High marginal taxpayers tend to seek more tax-favored investments relative to taxable investments The reason for this is that the explicit tax that these taxpayers avoid is greater than the implicit tax they are paying when purchasing tax-favored investments Despite the fact that before-tax returns are generally higher for taxable investments, the high marginal tax rate applicable to less favorably taxed investments will tend to decrease after-tax returns below the returns on tax-favored investments On the other hand, low marginal rate taxpayers will generally prefer less favorably taxed investments because the implicit taxes they avoid by not purchasing tax-favored investments tends to be greater than the explicit taxes they pay, if any, on the less tax favored investments they actually purchase AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Analyze Blooms: Understand Learning Objective: 11-03 Describe common sources of tax-exempt investment income and explain the rationale for exempting some investments from taxation Level of Difficulty: Medium Topic: Portfolio income: Tax-exempt 11-76 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 90 Richard purchased a life insurance policy at a cost of $65,000 His two sons, Dale and Drew, were named the beneficiaries His policy promises a return of 7.5 percent per year if Richard dies after his normal life expectancy of 25 years Due to a recent recession, Richard must cash out his policy after 15 years How much cash will Richard receive after-taxes and what is his after-tax rate of return? Assume Richard's marginal tax rate is 30% Richard's after tax proceeds are $154,129 and his after-tax rate of return is 5.92% Feedback: See calculations below: Step 1: Cash surrender value received [$65,000 * (1 + 075)15] = $192,327 Step 2: Gain $192,327 - $65,000 = $127,327 Step 3: Tax on cash surrender value $127,327 × 30 = $38,198 Step 4: After-tax proceeds $192,327 - $38,198 = $154,129 Step 5: After-tax rate of return [($154,129/$65,000)1/15 - 1] = 5.92% AACSB: Analytic AICPA: BB Critical Thinking Blooms: Analyze Learning Objective: 11-03 Describe common sources of tax-exempt investment income and explain the rationale for exempting some investments from taxation Level of Difficulty: Medium Topic: Portfolio income: Tax-exempt 91 Compare and contrast the advantages and disadvantages of Coverdell Educational Savings Plans and 529 Plans Coverdell Educational Savings Plan Advantages (529 Plan Disadvantages) • Distributions may be used to pay for kindergarten through 12 th grade (Distributions from 529 may only be used to pay for higher education expenses) • Flexibility in determining where to invest funds (Investors are limited to investments offered by 529 plans) Coverdell Education Savings Plan Disadvantages (529 Plan Advantages) • Yearly contributions limited to $2,000 per beneficiary (the median contribution limit for state sponsored 529 plans is well over $200,000) • The $2,000 contribution limit phases out at higher levels of AGI (No phase-out of 529 plan contributions) AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Analyze 11-77 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Blooms: Understand Learning Objective: 11-03 Describe common sources of tax-exempt investment income and explain the rationale for exempting some investments from taxation Level of Difficulty: Medium Topic: Portfolio income: Tax-exempt 92 Phil and Emily Brooks have three sons, Jason, 16, Tom, 12, and Adam, 10 They create a Colorado 529 plan for each of their sons by investing $10,000 in three different plans Each of these investments yields a constant return of 6.5 percent When they turned 18, Jason and Adam withdrew the funds in their 529 plans and used the money for higher education expenses while Tom withdrew the funds in his 529 plan to start a new business Assuming that each of the sons have a 15 percent marginal tax rate when they turn 18, how much money will each of the three boys have after paying all applicable taxes due? (Round all interim and final calculations to the nearest whole number) Jason will have $11,342, Adam will have $16,550, and Tom will have 13,443 Feedback: See computations below: Jason [$10,000 × (1 + 065)2] = $11,342 Adam [$10,000 × (1 + 065)8] = $16,550 Tom [$10,000 × (1 + 065)6] = $14,591 $14,591 - $10,000 = $4,591 $4,591 × 25 (15% marginal rate + 10% penalty) = $1,148 $14,591 - $1,148 = $13,443 AACSB: Analytic AICPA: BB Critical Thinking Blooms: Analyze Learning Objective: 11-03 Describe common sources of tax-exempt investment income and explain the rationale for exempting some investments from taxation Level of Difficulty: Medium Topic: Portfolio income: Tax-exempt 11-78 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 93 What are the tax and nontax consequences associated with purchasing a whole life insurance policy on your life? A whole life insurance policy can be used as a tax-favored investment The amount paid out at time of death will be tax-exempt to the beneficiary of the policy Also, the cash surrender value of the policy will grow free of tax as long as the invested premiums generate positive returns If the owner of the policy elects to receive the cash surrender value before his death, he must pay taxes on his investment gains (i.e., the difference between the cash surrender value of the policy and the amount invested in the policy) Regarding nontax consequences, purchasing life insurance policies can result in high commissions and fees These costs will reduce the before-tax return of life insurance relative to other investments Overall, life insurance is a relatively tax favorable investment if held until time of death, but the costs associated with life insurance may overwhelm the tax benefits AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Analyze Blooms: Understand Learning Objective: 11-03 Describe common sources of tax-exempt investment income and explain the rationale for exempting some investments from taxation Level of Difficulty: Medium Topic: Portfolio income: Tax-exempt 94 How are individual taxpayers' investment expenses and investment interest expense treated for tax purposes? Investment expense: This is any expense incurred to acquire or manage taxable investments, excluding interest Investment expenses are treated as miscellaneous itemized deductions subject to the 2% of AGI floor Thus, investment expenses result in tax deductions if investors itemize and if such expenses exceed the percent of AGI floor These expenses are only deductible in the year incurred Investment interest expense: This is a specific expense that relates to the interest on loans taxpayers obtain to purchase portfolio investments The amount a taxpayer is able to deduct depends on whether the taxpayer itemizes deductions for the year The deduction for investment interest expense is limited to the taxpayer's net investment income for the year Any investment interest expense in excess of a taxpayer's net investment income may be carried forward indefinitely until the taxpayer has enough net investment income to use the deduction AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Analyze Blooms: Understand Learning Objective: 11-04 Calculate the deduction for portfolio investment-related expenses; including investment expenses and investment interest expense Level of Difficulty: Medium Topic: Portfolio investment expenses 11-79 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 95 Sarantuya, a college student, feels that now is a good time to buy stocks However, because she doesn't have any savings, she decides to borrow $15,000 at an annual interest rate of percent She must make an interest-only payment each year for five years plus repay the entire principal in year five On August 1, 20X8 when Sarantuya obtained the loan, Sarantuya invested $10,000 in several individual stocks and used the remaining $5,000 to pay her tuition for the year Assuming Sarantuya's net investment income this year is greater than her investment interest expense this year, how much investment interest expense can she deduct in 20X8? Sarantuya is allowed to deduct up to $333 in investment interest expense Feedback: See calculations below: Step 1: Interest expense for 20X8 [$15,000 × 08 × (5/12)] = $500 Step 2: Proportion amount of loan used for investment and personal use Individual stocks: $10,000/$15,000 = 67% Tuition: $5,000/$15,000 = 33% Step 3: Use percentages from Step to allocate the correct interest expense that is allowed to be deductible Investment interest expense: $500 × 67 = $333 Nondeductible personal interest: $500 × 33 = $167 AACSB: Analytic AICPA: BB Critical Thinking Blooms: Analyze Learning Objective: 11-04 Calculate the deduction for portfolio investment-related expenses; including investment expenses and investment interest expense Level of Difficulty: Medium Topic: Portfolio investment expenses 11-80 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 96 Dan and Sue Hill file a joint tax return and elect to itemize their deductions For 20X7, the Hills received the following income items: (1) $150,000 salary, (2) $3,000 long-term capital gain, and (3) $1,500 interest income Other than these amounts, no other events or transactions affected their AGI in 20X7 During the same year, the Hills incurred the following expenses: (1) $500 tax preparation fees, (2) $4,000 investment expenses, and (3) $10,000 additional miscellaneous expenses Assuming the Hills have a marginal tax rate of 30 percent, what is the tax benefit they receive from the investment expenses they paid? Tax savings of $1,200 for the Hills related to their investment expenses Feedback: See calculations below: Step 1: Calculate AGI and calculate total miscellaneous expenses AGI: $150,000 + $3,000 + $1,500 = $154,500 Miscellaneous itemized expenses: $500 + $4,000 + $10,000 = $14,500 Step 2: Calculate the 2% AGI floor $154,500 × 02 = $3,090 Step 3: Calculate amount of miscellaneous itemized deductions in excess of the AGI floor $14,500 - $3,090 = $11,410 Because the total $11,400 miscellaneous itemized deduction is greater than the $4,000 of investment expenses, the Hills receive a tax benefit for all $4,000 of their investment expenses Given their marginal tax rate of 30%, the tax benefit is equal to $4,000 × 30% or $1,200 AACSB: Analytic AICPA: BB Critical Thinking Blooms: Analyze Learning Objective: 11-04 Calculate the deduction for portfolio investment-related expenses; including investment expenses and investment interest expense Level of Difficulty: Medium Topic: Portfolio investment expenses 97 How can electing to include long-term capital gains and qualifying dividends in the computation of net investment income be beneficial to taxpayers? If taxpayers elect to include long-term capital gains and qualifying dividends in net investment income, these income items must be taxed at ordinary rates rather than at the preferential capital gains rates This detriment may be more than offset by the additional investment interest expense that becomes deductible as net investment income is increased by virtue of making the election Taxpayers considering this election should compare the current benefit of making this election with the loss of future benefits from taking the investment interest expense deduction in the future Fortunately, the election doesn't require all capital gains and qualifying dividends to be taxed at ordinary rates Instead, taxpayers can elect to include only the amount of long-term capital gains and qualifying dividends that will provide the greatest current benefit AACSB: Reflective Thinking AICPA: BB Critical Thinking 11-81 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Blooms: Analyze Blooms: Understand Learning Objective: 11-04 Calculate the deduction for portfolio investment-related expenses; including investment expenses and investment interest expense Level of Difficulty: Medium Topic: Portfolio investment expenses 98 Kerri, a single taxpayer who itemizes deductions on Schedule A, incurs $15,000 of interest expense on funds borrowed to acquire taxable bonds Kerri also has $20,000 of taxable interest income for the year Assume Kerri is in a 30% marginal tax bracket How much of the interest expense can she deduct? Assuming the same facts except that the $20,000 of investment income is a qualifying dividend rather than taxable interest income, what should Kerry if she wants to minimize her current year tax liability? She can deduct $15,000 of investment interest expense If the investment income is a qualifying dividend, she should elect to treat $15,000 of the qualifying dividend as investment income Feedback: See calculations below: First question: Second question: *Kerri only wants to elect to treat an amount of the qualifying dividend as investment income ($15,000) so as to allow her to deduct all of the investment interest expense This allows her to deduct all $15,000 of the investment interest expense and still be able to tax $5,000 of the qualifying dividend @ 15% rather than all $20,000 of the qualifying dividend @ 30% AACSB: Analytic AICPA: BB Critical Thinking Blooms: Analyze 11-82 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Learning Objective: 11-04 Calculate the deduction for portfolio investment-related expenses; including investment expenses and investment interest expense Level of Difficulty: Medium Topic: Portfolio investment expenses 99 The Crane family recognized the following types of investment income during 20X6: (1) $1,500 qualified dividends, (2) $3,000 long-term capital gains, and (3) $850 taxable interest Additionally, the Crane family has $500 in investment expenses and their other miscellaneous itemized deductions exceed 2% of their AGI for the year The Crane family paid $3,333 in investment interest expense during 20X6 What is the best option for the Crane family if they want to maximize their deduction in 20X6 for investment interest expense? Show all possibilities Elect to include only $2,983 of long-term capital gain in net investment income Feedback: See calculations below: Option 1: No election Net investment income: $850 - $500 = $350 Investment interest expense allowed to deduct: $350 Investment interest expense carried forward: $3,333 - 350 = $2,983 Option 2: Election to include all qualified dividends in investment income Net investment income: $1,500 + $850 - $500 = $1,850 Investment interest expense allowed to deduct: $1,850 Investment interest expense carried forward: $3,333 - $1,850 = $1,483 Option 3: Election to include all long-term capital gains in investment income Net investment income: $3,000 + $850 - $500 = $3,350 Investment interest expense allowed to deduct: $3,333 Investment interest expense carried forward: $0 Pay higher tax rate on excess $17 elected Option 4: Election to include all qualified dividends and all long-term capital gains in investment income Net investment income: $1,500 + $3,000 + $850 - $500 = $4,850 Investment interest expense allowed to deduct: $3,333 Investment interest expense carried forward: $0 Pay higher tax rate on excess $1,517 elected Option 5: Election to include only $2,983 of long-term capital gains in net investment income Net investment income: $2,983 + $850 - $500 = $3,333 Investment interest expense allowed to deduct: $3,333 Investment interest expense carried forward: $0 Option is superior to options and because it subjects the minimum amount of long-term capital gain to ordinary rates while maintaining the net investment interest carried forward at Other combinations of long-term capital gain and qualifying dividends totaling $2,983 would also be acceptable AACSB: Analytic AICPA: BB Critical Thinking Blooms: Analyze Learning Objective: 11-04 Calculate the deduction for portfolio investment-related expenses; including investment expenses and investment interest expense Level of Difficulty: Hard Topic: Portfolio investment expenses 11-83 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 100 Describe the three main loss limitations that taxpayers must overcome before deducting losses allocated to them from a specific activity Tax basis - limits the amount of deductible loss to the tax basis the taxpayer has in the activity Thus, losses from an activity may not reduce the tax basis in that activity below zero Losses in excess of the taxpayer's basis are carried forward until the taxpayer's basis becomes positive again At-risk amount - limits the amount of deductible loss to the amount the taxpayer has at risk in the activity Generally, the taxpayer's at risk amount corresponds to his tax basis except that debt allocated to the taxpayer and included in tax basis is not included in the taxpayer's amount at risk if he is not responsible for repaying the debt However, an exception to this general rule is qualified nonrecourse financing that is included in the taxpayer's amount at risk Losses limited by the taxpayer's amount at risk are carried forward and deducted when the taxpayer's amount at risk becomes positive again Passive loss limits - limits the amount of loss from any passive activity (activities in which the taxpayer does not materially participate) to the taxpayer's passive income for the year Limited partnerships and rental activities are generally considered to be passive activities Losses limited by the passive activity loss rules are carried forward until the taxpayer generates passive income or until the taxpayer disposes of the activity producing the passive losses AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Analyze Blooms: Understand Learning Objective: 11-05 Understand the distinction between portfolio investments and passive investments and apply tax basis; at-risk; and passive activity loss limits to losses from passive investments Level of Difficulty: Medium Topic: Passive activity income and losses 11-84 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 101 Given that losses from passive activities can only offset income from passive activities unless the passive activity is sold, what types of activities are not considered to be passive? Name at least three ways a taxpayer may be treated as an active participant in an activity To be considered an active participant in an activity, a taxpayer must materially participate in the activity An individual will qualify as a material participant in an activity if any one of the seven tests below is satisfied: The individual participates in the activity more than 500 hours during the year The individual's activity constitutes substantially all of the participation in such activity by all individuals including non-owners The individual participates more than 100 hours during the year, and the individual's participation is not less than any other individual's participation in the activity The activity qualifies as a "significant participation activity" (more than 100 hours) and the aggregate of all "significant participation activities" is greater than 500 hours for the year The individual materially participated in the activity for any five of the preceding 10 taxable years The individual materially participated for any three preceding years in any personal service activity (personal services in health, law, accounting, architecture, etc.) Taking into account all the facts and circumstances, the individual participates on a regular, continuous, and substantial basis during the year AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Analyze Blooms: Apply Learning Objective: 11-05 Understand the distinction between portfolio investments and passive investments and apply tax basis; at-risk; and passive activity loss limits to losses from passive investments Level of Difficulty: Hard Topic: Passive activity income and losses 11-85 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 102 Roy, a resident of Michigan, owns 25 percent of a fourplex in the nearby college town of Ann Arbor with three other friends The fourplex is rented to students who attend the University of Michigan Roy's responsibility is to approve new tenants each year and take care of any maintenance issues During the year, the rental property generated a $25,000 loss which was split equally among Roy and his three friends Assuming Roy's only source of income was $145,000 of salary, how much of the rental loss can Roy deduct this year and what amount must be carried forward? Current year deduction - $2,500 and carried forward amount - $3,750 Feedback: See calculations below: Step 1: Portion of rental loss to Roy $25,000/4 = $6,250 Step 2: Maximum deduction for current year after phase-out limitations $25,000 - [($145,000 - $100,000) × 5] = $2,500 Step 3: Rental loss allowed to be deducted for current year and amount carried forward Deducted for current year: $2,500 Carried forward: $6,250 - $2,500 = $3,750 AACSB: Analytic AICPA: BB Critical Thinking Blooms: Analyze Learning Objective: 11-05 Understand the distinction between portfolio investments and passive investments and apply tax basis; at-risk; and passive activity loss limits to losses from passive investments Level of Difficulty: Medium Topic: Passive activity income and losses 11-86 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 103 Judy, a single individual, reports the following items of income and loss: Judy owns 100% of the rental property and actively participates in the rental of the property Calculate Judy's AGI $105,000 Feedback: See calculations below: AACSB: Analytic AICPA: BB Critical Thinking Blooms: Analyze Learning Objective: 11-05 Understand the distinction between portfolio investments and passive investments and apply tax basis; at-risk; and passive activity loss limits to losses from passive investments Level of Difficulty: Medium Topic: Passive activity income and losses 11-87 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 104 On January 1, 20X8, Jill contributed $18,000 of cash to the XYZ limited partnership for a 25 percent limited partnership interest On April 6, 20X8, XYZ, limited partnership distributed $2,000 to Jill For the year ended December 31, 20X8, Jill received the following income/loss allocations from her partnership investments: (1) XYZ, limited partnership allocated a $5,000 loss to Jill (2) ABC limited partnership allocated $2,300 of income to Jill How much of the $5,000 loss from XYZ limited partnership can Jill deduct in 20X8? $2,300 of loss from XYZ is deducted in 20X8 Feedback: See calculations below: Jill has sufficient tax basis and amount at-risk in XYZ to deduct her $5,000 loss allocation from XYZ; however, she must assess how much passive income she has from other sources that she may offset with her $5,000 passive loss from XYZ Because she is a limited partner in XYZ and ABC, her losses and income from these activities are considered to be passive The only passive income she has is $2,300 from ABC Thus, she would only be allowed to deduct $2,300 of her $5,000 loss from XYZ this year and must carry forward $2,700 of the remaining loss until she generates additional passive income in the future or sells her interest in XYZ AACSB: Analytic AICPA: BB Critical Thinking Blooms: Analyze Learning Objective: 11-05 Understand the distinction between portfolio investments and passive investments and apply tax basis; at-risk; and passive activity loss limits to losses from passive investments Level of Difficulty: Hard Topic: Passive activity income and losses 11-88 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education ... income of $2,800 and a NSTCL carryforward of $7,200 D an offset against ordinary income of $3,000 and a NSTCL carryforward of $7,200 E an offset against ordinary income of $3,000 and a NSTCL carryforward... at time of sale and added to basis of the newly acquired stock D not recognized at time of sale and added to basis of the newly acquired stock E not recognized at time of sale and subtracted from... average D Specific identification E None of these 38 Long-term capital gains can be taxed at a maximum rate of: A 20 percent B 25 percent C 28 percent D Both 20 percent and 28 percent E All of these