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Prentice Hall's Federal Taxation 2013 Individuals, 26e (Pope) Chapter I6 Deductions and Losses

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1) To be tax deductible, an expense must be all of the following except A) ordinary and necessary. B) paid in cash. C) reasonable in amount. D) an expense of the taxpayer. 2) Which of the following is not required for an expenditure to be deductible as a business or investment expense? A) recurring in nature B) ordinary and necessary C) reasonable in amount D) incurred by the taxpayer 3) Which of the following expenditures is tax deductible? A) capital expenditures B) expenses related to tax-exempt income C) expenses related to a trade or business D) expenses that are illegal or in violation of public policy 4) Maria pays the following legal and accounting fees during the year: Legal fees in connection with trade or business Legal fees related to purchase of personal residence Legal fees related to tax deficiency related to Schedule A itemized deductions Tax return preparation fees: Allocable to preparation of Schedule C Tax return preparation fees: Allocable to preparation of remainder of return What is the total amount of her for AGI deduction for these fees? A) $4,000 B) $6,000 C) $8,100 D) $11,200 $4,000 2,600 500 2,000 2,100

5) Leigh pays the following legal and accounting fees during the year: Legal fees in connection with a contract dispute in her trade or business Legal fees related to resolving a tax deficiency related to business Tax return preparation fees: TAX2000 Fall 2012 Chapter 6 $8,800 4,000 1,000

Allocable to Schedules A and B Tax return preparation fees: Allocable to Schedule C Legal fees incident to a divorce What is the total amount of her for AGI deduction for these fees? A) $10,800 B) $14,000 C) $15,000 D) $20,000

1,200 5,000

6) During the current year, Martin purchases undeveloped land as an investment. Martin intends to rent the land as pastureland and hopefully sell it later for a profit. In the current year, Martin receives no rent but he does pay taxes of $2,800, mortgage interest of $900 and liability insurance of $500. How much of these expenses can Martin deduct (before any limitations) on his current tax return? A) $0 B) $1,400 C) $3,700 D) $4,200 7) Pamela was an officer in Green Restaurant which subsequently went bankrupt. Pamela started a new restaurant and, to establish goodwill, paid off the debts of $100,000 of Green Restaurant. She was under no obligation to do so. The $100,000 is A) deductible currently as an itemized deduction. B) capitalized because the expenses are not ordinary. C) deductible currently as a trade or business expense since the expenses are considered ordinary and necessary business expenses. D) None of the above. 8) Laura, the controlling shareholder and an employee of Southwest Corporation, receives an annual salary of $750,000. Based on several factors including the size of the corporation's operations and a comparison of salary received by officers of comparably-sized corporations, the IRS contends that Laura's salary should be no higher than $600,000. The Court upheld the IRS's position. As a result, which of the following is true? A) $600,000 is deductible by the corporation; $600,000 is taxable to Laura. B) $600,000 is deductible by the corporation; $750,000 is taxable to Laura. C) $750,000 is deductible by the corporation; $750,000 is taxable to Laura. D) $750,000 is deductible by the corporation; $600,000 is taxable to Laura.

9) Carole owns 75% of Pet Foods, Inc. As CEO, Carole must travel extensively and does so on the company jet. In addition, she also uses the jet to take several personal vacations. Carole reports the value of the personal use of the jet, $140,000, as additional compensation. Which of the following is true in terms of the corporation? A) The corporation includes $140,000 as miscellaneous income. B) The $140,000 has no impact on the corporation's income tax. C) The corporation takes a deduction of $140,000 for compensation expense. D) The corporation takes a deduction of $140,000 for dividend expense. 10) Mark and his brother, Rick, each own farms. Rick is experiencing severe financial difficulties and cannot afford to buy feed for his cattle. Mark purchases $2,000 of feed and gives Rick one-half of the feed. Mark tells Rick that there is no need to repay him and to TAX2000 Fall 2012 Chapter 6

consider the feed a gift. Which of the following statements is true? A) Mark can deduct $2,000 for the feed. B) Mark can deduct $1,000 for the feed. C) Rick must report $1,000 as income. D) None of the above is true. 11) Which of the following factors is important in distinguishing between capital and revenue expenditures? A) The expenditure improves the property, adding to the value of the property. B) The expenditure provides a betterment, adding to the value of the property. C) The expenditure restores the property. D) All of the above. 12) During 2011 and 2012, Danny pays property taxes of $3,500 each year on a piece of land. During 2011, the land is vacant and unproductive. In 2012 Danny uses the land as a parking lot and generates $16,000 in income. Which of the following is true regarding the property taxes? A) Capitalize $3,500 each year. B) Deduct $3,500 each year. C) Capitalize $3,500 in 2011 and deduct $3,500 in 2012. D) Either B or C is acceptable. 13) During the current year, Ivan begins construction of an office building and a hotel. He incurs $10,000 in property taxes during the construction of the office building and $15,000 for the hotel. Which of the following statements is true of the property taxes during the construction period? A) Ivan must capitalize the property taxes on both properties each year if an election is made. B) Ivan must deduct the property taxes on both properties each year. C) Ivan may elect to capitalize the property taxes on one of the properties while deducting the property taxes on the other for each year. D) Ivan may elect to capitalize the property taxes for the properties in one year and then deduct the property taxes on the properties the next year. 14) Emeril borrows $340,000 to finance taxable and tax-exempt investments. He incurs $18,000 investment interest expense, allocated equally between the taxable and tax-exempt investments. Ignore any possible investment interest expense limitation. How much of the interest expense is deductible, and where is it deductible? A) $18,000 for AGI B) $18,000 from AGI C) $9,000 for AGI D) $9,000 from AGI 15) Jimmy owns a trucking business. During the current year he incurred the following: Gasoline and Oil $ 100,000 Maintenance $ 15,000 Fines for Speeding and Illegal parking $ 8,000 Bribes to Government Inspection Officials $ 21,000 What is the total amount of deductible expenses? A) $115,000 B) $123,000 C) $108,000 D) $144,000 16) During the current year, the United States files criminal and civil actions against Joe, the TAX2000 Fall 2012 Chapter 6

CEO of Box Corporation, and Jane, the president of Cable Corporation, for price fixing. Both enter pleas of no contest and appropriate judgments are entered. Subsequent to this action, Square Corporation sues both Box and Cable for treble damages of $6,000,000. In settlement, Box and Cable each pay Square $1,200,000. What is the maximum amount that Box and Cable may each deduct? A) $400,000 B) $1,200,000 C) $2,000,000 D) $6,000,000 17) Troy incurs the following expenses in his business (illegal gambling establishment): Salaries to employees, $200,000; insurance expense, $60,000; utilities expense, $70,000; and bribes to police, $60,000. His deductible expenses are A) $-0-. B) $200,000. C) $330,000. D) $390,000. 18) Pat, an insurance executive, contributed $1,000,000 to the re-election campaign of Governor Stephens, in hopes that Stephens will appoint her to a coveted position on the State Board of Insurance. How much of the contribution can Pat deduct? A) $0 B) $100,000 C) $500,000 D) $1,000,000 19) American Healthcare (AH), an insurance company, is trying to persuade Congress to enact nationwide anti-smoking legislation. As part of this effort, AH paid $500,000 to hire a lobbying firm to discuss its concerns with members of Congress. AH also contributed $100,000 to candidates for political office who support limiting public smoking. What amount of these expenditures can AH deduct? A) $0 B) $100,000 C) $500,000 D) $600,000 20) In March of the current year, Marcus began investigating the possibility of opening a specialty clothing store. From March through June, he spent $2,300 on a market survey, $2,700 in consulting fees to find the best location and $3,600 in professional fees setting up an accounting and inventory system. Although he had never run his own business before, on August 1 he opened his doors for business. What is the maximum amount of deduction for the current year attributable to these expenditures? A) $0 B) $5,000 C) $5,100 D) $8,600 21) Toby, owner of a cupcake shop in New York, is considering opening a similar business (i.e., a cupcake shop) in Phoenix. After spending $4,200 investigating such possibilities in Phoenix, Toby decides against opening the store. What is the maximum amount of deduction for the current year attributable to these expenditures? A) $-0B) $420 C) $840 D) $4,200 TAX2000 Fall 2012 Chapter 6

22) Jones, Inc., a calendar-year taxpayer, is in the air conditioner repair business. The business uses the cash method. In December of the current year, Jones charged $100 of supplies at Refrigeration, Inc., (he will pay the credit card bill in January) and also purchased $600 of supplies at XYZ on open account (he will make a payment on the open account in January). What is the amount that is deductible by Jones, Inc., in the current year? A) $100 B) $600 C) $700 D) The amounts must be capitalized and charged to expense as used. 23) On August 1 of this year, Sharon, a cash method taxpayer, signs a lease for office space and begins business. The lease is for 3 years. At the time the lease is signed, Sharon pays the $12,600 rent for the entire 36-month lease term. How much can Sharon deduct this year? A) $350 B) $1,750 C) $5,950 D) $12,600

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24) On December 1, Robert, a cash method taxpayer, borrows $10,000 from the bank for use in his business. Under the terms of the loan, the bank discounts the loan by $300, paying Robert the $9,700 cash proceeds. If Robert repays the loan next year, he may deduct A) $300 next year. B) $300 this year. C) $25 this year and $275 next year. D) nothing since the note is "noninterest-bearing." 25) In which of the following situations are points paid on a home mortgage loan not deductible in the year of payment? A) purchase B) refinance C) construction D) improvement 26) On August 1 of the current year, Terry refinances her home and borrows $240,000. Terry is required to pay two points on the loan. The loan is secured by the residence and the charging of points is an established business practice in the area. The term of the loan is 20 years, beginning on August 1 of the current year. How much, if any, of the points may Terry deduct in the current year? A) $0 B) $100 C) $240 D) $4,800 27) On July 1 of the current year, Marcia purchases a new home and borrows $320,000. Marcia is required to pay two points on the loan. The loan is secured by the residence and the charging of points is an established business practice in the area. The term of the loan is 20 years, beginning on July 1 of the current year. How much, if any, of the points may Marcia deduct in the current year? A) $0 B) $160 C) $3,200 D) $6,400 28) Which of the following is not required for an accrual method taxpayer to currently deduct the cost of services received? A) The liability must be paid. B) The existence of a liability must be established. C) The amount of the liability is determined with reasonable accuracy. D) The services must actually be provided. 29) All of the following statements are true except A) A tax deduction is allowed to a taxpayer for estimated warranty expense. B) A tax deduction is allowed in association with a warranty only in the year in which warranty work is performed. C) A tax deduction is allowed for a contested amount if the amount is paid prior to final settlement. D) No tax deduction is allowed to an accrual basis taxpayer for the amount of a down payment for a non-recurring expense when the work is to be performed in a subsequent period. 30) Under the accrual method, recurring liabilities may be deducted currently and paid in the next period if all of the following are present except for A) the all-events test is met. B) the expense is recurring. C) the expense is material. TAX2000 Fall 2012 Chapter 6 6

D) economic performance occurs within the shorter of 8 1/2 months after the close of the year or a reasonable period after the close of the year. 31) Victor, a calendar year taxpayer, owns 100 shares of AB Corporation stock, which was purchased three years ago for $5,000. Victor sells all 100 shares on December 27, of the current year, for $4,000 and on January 5, of the following year, purchases 60 shares of AB Corporation stock. Victor's recognized loss will be A) $0. B) $400. C) $600. D) $1,000. 32) Ashley, a calendar year taxpayer, owns 400 shares of Yale Corporation stock that she purchased two years ago for $4,000. In the current year Ashley sells all 400 shares of the Yale Corporation stock for $2,400 on December 27. On January 4 of the following year, Ashley purchases 300 shares of Yale Corporation stock for $800. Ashley's recognized loss and her basis in the newly purchased 300 shares of Yale Corporation stock are A) Recognized Loss Basis $0 $3,200. B) Recognized Loss $400 C) Recognized Loss $1,200 D) Recognized Loss $1,600 Basis $2,000. Basis $2,000. Basis $ 800.

33) Samuel, a calendar year taxpayer, owns 100 shares of R Corporation common stock which was purchased two years ago for $3,600. Samuel sells all 100 shares on December 27 of the current year for $1,000. On January 4 of the following year, Samuel purchases 40 shares of R Corporation preferred stock. Samuel's recognized loss will be A) $0. B) $960. C) $1,040. D) $2,600. 34) Which of the following individuals is not considered a relative for purposes of the loss disallowance rules under Sec. 267? A) brother B) husband C) sister-in-law D) grandfather 35) Erin, Sarah, and Timmy are equal partners in EST Partnership. Sarah also owns 40% of Elton Corporation. The remaining shareholders of Elton Corporation are: Erin (24%) and Sarah's uncle (36%). What percent ownership does Sarah directly or constructively own in Elton Corporation? A) 40% B) 64% TAX2000 Fall 2012 Chapter 6

C) 76% D) 100% 36) Jason sells stock with an adjusted basis of $66,000 to JJ Inc., his 60% owned corporation, for its fair market value of $60,000. JJ Inc. sells the stock three years later for $67,000. JJ Inc.'s recognized gain or loss on the sale will be A) $-0-. B) ($3,000). C) $1,000. D) $4,000. Explanation: Selling Price Minus: Cost Gain Minus: Previously disallowed loss ($60,000 $66,000) Taxable gain 37) Donald sells stock with an adjusted basis of $38,000 to his son, Kiefer, for its fair market value of $30,000. Kiefer sells the stock three years later for $32,000. Kiefer will recognize a gain on the subsequent sale of A) $-0-. B) $2,000. C) ($6,000). D) ($8,000). Explanation: Selling Price Minus: Cost Gain Minus: Previously disallowed loss ($30,000 $38,000) Taxable gain

38) Dana purchased an asset from her brother for $15,000. Her brother's basis was $20,000. If Dana sells the asset to an unrelated party for $12,000, she will recognize A) $-0-. B) ($1,000) loss. C) ($3,000) loss. D) ($4,000) loss. Explanation: Selling Price Minus: Cost Loss 39) Sheila sells stock, which has a basis of $12,000, to her daughter for $7,000, the stock's fair market value. Subsequently, the daughter sells the stock to an unrelated party for $5,000. Which of the following is true for the Sheila and the Daughter? A) Sheila Daughter recognizes no loss recognizes loss of $2,000 TAX2000 Fall 2012 Chapter 6

B) Sheila recognizes no loss

Daughter recognizes loss of $5,000

C) Sheila Daughter recognizes loss of $3,000 recognizes loss of $5,000 D) Sheila Daughter recognizes loss of $3,000 recognizes loss of $2,000 40) Rob sells stock with a cost of $3,000 to his daughter for $2,200, which is its fair market value. Later the daughter sells the stock for $3,200 to an unrelated party. Which of the following describes the tax treatment to Rob and Daughter? A) Rob Recognizes no loss B) Rob Recognizes no loss C) Rob Recognizes $800 loss D) Rob Recognizes $800 loss Daughter Recognizes gain of $1,000 Daughter Recognizes gain of $200 Daughter Recognizes gain of $1,000 Daughter Recognizes gain of $200

41) Bart operates a sole proprietorship for which he uses the accrual method of accounting. Bart's sister Samantha, a cash method taxpayer, did some advertising work for Bart's business in November 2011. In December, Bart received a billing statement from Samantha for $5,000. Bart paid Samantha the $5,000 in January 2012. Both Bart and Samantha are calendar year taxpayers. When may Bart deduct the $5,000? A) 2011 B) 2012 C) Either 2011 or 2012 D) The expense is not deductible since Samantha is Bart's sister. 42) Which of the following factors is not used to determine whether an activity is a hobby or a business? A) the taxpayer's expertise in the activity B) the taxpayer's financial status C) the personal pleasure derived from the activity D) the success of the taxpayer in other dissimilar activities 43) For the years 2008 through 2012 (inclusive) Max, a surgeon, has been involved in raising poodles. Only in 2011 and 2012 did his income exceed the expenses from the activity. Which statement is correct? TAX2000 Fall 2012 Chapter 6

A) The activity is a business. The IRS cannot prove it is a hobby. B) The activity is a hobby. Max cannot prove it is a business. C) The activity is presumed to be a business. However, the IRS may prove it is a hobby. D) The activity is presumed to be a hobby. However, Max may prove it is a business. 44) For the years 2008 through 2012 (inclusive) Mary, a a best-selling author, has been involved in operating an antique store. In 2008, 2009 and 2010 her income exceeded the expenses from the activity. In 2011 and 2012, the antique store generated a loss. Which statement is correct? A) The activity is a business. The IRS cannot prove it is a hobby. B) The activity is a hobby. Mary cannot prove it is a business. C) The activity is presumed to be a business. However, the IRS may prove it is a hobby. D) The activity is presumed to be a hobby. However, Mary may prove it is a business. 45) Abigail's hobby is sculpting. During the current year, Abigail sold three of her sculptures for a total of $3,200. Her related expenses include $1,500 in utilities, $1,200 in supplies and $900 in depreciation. Of the total expenses incurred, Abigail may deduct A) $0. B) $1,500 in utilities and $1,200 in supplies. C) $1,500 in utilities, $1,200 in supplies, and $500 in depreciation. D) $1,500 in utilities, $1,200 in supplies and $900 in depreciation.

46) Kyle drives a race car in his spare time and on weekends. His records regarding this activity reflect the following information for the year. Income Entry fees Depreciation on car Gasoline Interest on home equity loan for race car Insurance premiums $7,800 2,100 1,700 1,000 800 2,500

What is the allowable deduction (before any AGI limitation) for depreciation assuming that this activity is not engaged in for profit and Kyle can itemize his deductions? A) $0 B) $300 C) $1,400 D) $1,700 Explanation: Income Minus: Interest on loan for race car Income before tier 2 expenses Tier 2 expense: Entry fees Tier 2 expense: Gasoline Tier 2 expense: Insurance premiums Total tier 2 expenses Net income before tier 3 expenses Depreciation on car Deductible depreciation (limit = TAX2000 Fall 2012 Chapter 6

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1,400) 47) Juanita knits blankets as a hobby and sells them. In the current year, she earns $5,000 from her blanket sales and incurs expenses of $600. Juanita does not itemize deductions. On her tax return, she should A) report $5,000 of hobby income and deduct $500 of hobby expenses from AGI. B) report $5,000 of hobby income and deduct $400 of hobby expenses for AGI. C) report $5,000 of hobby income and deduct nothing from AGI since Juanita does not itemize deductions. D) report no hobby income and no hobby deductions.

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48) Vanessa owns a houseboat on Lake Las Vegas that she personally uses for 25 days out of the year and rents for 280 days. For tax purposes, the houseboat is classified as: A) neither a residence nor rental property. Because it is rented a nominal number of personal use days, both revenue and expenses (other than those otherwise allowable) are ignored. B) rental property. Expenses in excess of income may be deducted although net income or loss is subject to the passive activity rules. C) property that is treated as a hobby which gives rise to from AGI deductions only. D) a combination of the taxpayer's residence and rental property. The deduction for expenses is limited to the amount of income generated by the property. 49) Mackensie owns a condominium in the Rocky Mountains. During the year, Mackensie uses the condo a total of 23 days. The condo is also rented to tourists for a total of 77 days and generates rental income of $10,900. Mackensie incurs the following expenses in the condo: Expense Mortgage interest Property taxes Utilities Insurance Depreciation Amount $ 5,000 3,500 2,500 1,800 11,000

Using the court's method of allocating expenses, the amount of depreciation that Mackensie may take with respect to the rental property will be A) $0. B) $1,044. C) $5,796. D) $11,000 Explanation: Rental income Minus: Mortgage interest (77/365 $5,000) Minus: Property taxes (77/365 $3,500) Minus: Utilities (77/100 $2,500) Minus: Insurance (77/100 $1,800) Minus: Depreciation (Remaining income) Taxable rental income 50) Abby owns a condominium in the Great Smokey Mountains. During the year, Abby uses the condo a total of 21 days. The condo is also rented to tourists for a total of 79 days and generates rental income of $12,500. Abby incurs the following expenses: Expense Mortgage interest Property taxes Utilities Insurance Depreciation Amount $ 4,100 1,900 2,200 1,200 10,000

Using the IRS method of allocating expenses, the amount of depreciation that Abby may take with respect to the rental property will be A) $ 5,074. B) $ 8,515. C) $ 7,900. TAX2000 Fall 2012 Chapter 6

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D) $10,000. Explanation: Income Mortgage interest ($4,100 79/100) Property taxes ($1,900 79/100 Income after tier 1 expenses Utilities ($2,200 79/100) Insurance ($1,200 79/100) Income after tier 2 expenses Depreciation ($10,000 79/100, limited to $5,074) 51) Nikki is a single taxpayer who owns a vacation cottage on the lake. During the year, she rented it for $2,000 for 14 days, lived in it for 56 days, and left it vacant the remainder of the year. The year's expenses amounted to $5,000 interest expense, $800 property taxes, $1,500 utilities and maintenance, and $2,400 depreciation. Using the IRS method of allocating expenses, how much of the property-related expenses will be deductible for AGI? A) 0 B) $2,000 C) $1,940 D) $9,700 52) Brent must substantiate his travel and entertainment expenses. Which of the following is not required for documentation? A) company expense report B) business relationship to the taxpayer of individuals entertained C) purpose of the expenditure D) time and place of the travel or entertainment

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