Federal Taxation: Ch. 4

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What is a qualified education loan for purposes of the student loan interest deduction?
A qualified education loan is a loan incurred by the taxpayer solely to pay qualified education expenses incurred on behalf of the taxpayer, taxpayer's spouse, or any dependent of the taxpayer at the time the loan was incurred.
What are qualified education expenses for purposes of the student loan interest deduction?
Qualified education expenses are the costs of attendance at an eligible educational institution. These expenses include tuition, fees, books, supplies, room, board, and other necessary expenses of attendance. The expenses must be reduced by certain nontaxable income related to education.
For purposes of the student loan interest deduction, what is modified AGI, and how is it determined?
Modified AGI is equal to AGI on the taxpayer's return plus (a) any deduction for student loan interest, (b) any foreign, U.S. possession, or Puerto Rican income excluded from taxable income, (c) any deduction taken for tuition and fees, and (d) any deduction taken with regard to domestic activities production.
For purposes of student loan interest deduction, what is an eligible educational institution?
An eligible educational institution is a post secondary educational institution eligible to participate in the federal student loan program.
Explain the limitations associated with the deductibility of student loan interest.
The interest must be incurred in conjunction with a qualified education loan used to pay qualified education expenses at an eligible educational institution. The modified AGI of the taxpayer must be less than $160,000 for a married taxpayer or $80,000 for a single taxpayer (a phaseout period begins at modified AGI of $130,000 for married taxpayers and $65,000 for single taxpayers). Deductible interest is limited to $2,500 per year.
In 2012, Shinobu incurred a loan to pay for qualified higher education expenses for her 20-year-old daughter who was a dependent. In 2016, her daughter graduated from college, moved away to start a new job, and ceased to be a dependent on Shinobu tax return. Shinobu started making payments on the loan in 2016. Without regard to any modified adjusted gross income limitations, is Shinobu permitted to deduct interest on the loan?
Yes. Higher education loans must be for education expenses for the taxpayer or dependent. The dependent limitation is applicable when the loan is incurred, not repaid.
Explain the purpose of a health savings account (HSA).
A Health Savings Account (HSA) is a tax-exempt savings account for qualified medical expenses. Its purpose is to grant some relief to those who have high deductible health plans and must pay significant out-of-pocket costs for medical care until the plan deductibles have been met.
What are the qualifications to be eligible for a Health Savings Account (HSA) deduction?
To qualify for an HSA, a taxpayer must be either self-employed, or an employee (or spouse) of an employer who maintains a high deductible health plan (HDHP), or an employee of a company that has no health coverage and the employee has purchased a high deductible health plan on his or her own.
What are the consequences of an employer contribution to an employee's HSA?
If the employer contributes to an HSA on behalf of an employee, the amount is not deductible as an above-the-line deduction by the employee, but the payment is not counted as income to the employee.
Explain the three tests associated with deductibility of moving expenses.
First, the move must be as a result of a change in the taxpayer's principal place of work. A taxpayer who has moved to start work for the first time qualifies provided that he or she meets the distance test. Second, the new job location must be at least 50 miles farther from the taxpayer's old residence than was the old job location. Third, the taxpayer must either (a) be a full-time employee for a period of 39 weeks during the first 12 months in the new area or (b) be self-employed for 78 weeks during the first 24 months in the new location, 39 of which must be during the first 12-month period.
Describe the types of expenses that can be deducted for moving expenses.
A taxpayer can deduct reasonable expenses for moving household goods and personal effects and for traveling from the old residence to the new residence. Certain expenses associated with the temporary storage of household goods for a limited period of time are also deductible. Meals are generally not included as a deductible moving expense. House hunting costs are also not included as a deductible moving expense.
A taxpayer incurs moving expenses in conjunction with a job-related move that meets the distance test. At the end of the year, the taxpayer has not yet met the time test. Under what circumstances can the taxpayer deduct the moving expenses?
If the taxpayer expects to be able to comply with the time test, the taxpayer can choose to deduct the moving expenses in the year incurred. The taxpayer also has the option to wait until the time test has been met and then file an amended return for the year the expenses were incurred.
Rica quit her job in Austin TX and moved to Seattle WA, incurring $1,500 of moving expenses, none of which was reimbursed by her employer. Upon arriving in Seattle, she sought employment and found a position three weeks later. Without regard to the time test, what amount, if any, of her moving expenses can Rica deduct?
Rica can deduct the entire $1,500. It is not necessary that Rica have a job prior to moving.
In January 2016, Jeff incurred $1,200 of moving expenses when he moved from Des Moines, IA, to Detroit, MI. When he moved, he had no job but found one a week after moving. He stayed on that job for two months, changed to another job for four months, and changed again to a long-term position that he held for the remainder of the year. What is the amount of moving expense deduction Jeff can report in 2016, if any?
Jeff can deduct the entire $1,200. It is not necessary that the time test be met with reference only to the first job at the new location, only that the full-time employment is in the same general location as the first job.
Explain why self-employed taxpayers generally pay double the amount of FICA taxes that regular wage earners do.

*Question 15
The FICA tax is a matching tax, in that generally ½ is paid by the employee, usually through payroll deduction, and ½ is paid by the employer. In the case of self-employed persons, they are essentially both parties, the employee and employer, and therefore, self-employed persons must pay both halves of the tax.
Refer to Question 15. How does the tax code attempt to remedy this seeming inequity?
Self-employed taxpayers are allowed to take a "for AGI", or above-the-line deduction, for ½ of the paid self-employment or FICA tax, which is calculated on Form SE.
Explain the two limitations associated with the deduction for health insurance by self-employed individuals.
First, the deduction cannot exceed net earnings from self-employment. Second, the taxpayer cannot be eligible to participate in any subsidized health plan maintained by any employer of the taxpayer or the taxpayer's spouse. This determination is made on a monthly basis, so conceivably there could be a portion of a year where a taxpayer is eligible for this deduction and then, after insurance eligibility for a subsidized plan occurs, would not be eligible for any further deduction.
What is meant by a penalty on early withdrawal of savings, and under what circumstances is it deductible?
Banks often require minimum or fixed deposit periods for many certificates of deposit or time savings accounts and impose an interest penalty if the funds are withdrawn prior to the end of the agreed-upon term. This penalty is a penalty on early withdrawal of savings. The amount of the penalty is deductible as a for AGI deduction.
Define alimony, child support, and property settlement.
Each of these items is determined in conjunction with a divorce or legal separation and generally is created with reference to the divorce decree or separation agreement. Alimony is a cash payment made under the provisions of the appropriate document for the support of the receiving spouse. There are certain additional specific requirements that must be met for the payment to be considered alimony. Child support is a fixed payment payable for the support of the children of the payer. A property settlement is a division of property of the marital community incident to a divorce. Of these three items, only alimony has a tax effect and that is why it is important to be able to distinguish between the three.
Why is it important to distinguish between a property settlement and alimony?
A property settlement does not result in income or deduction to either spouse. However, in the year received/paid, alimony is taxable to the payee spouse and deductible by the payer spouse as a for AGI deduction.
Who is eligible to take an above-the-line AGI deduction for educator expenses and what is the maximum amount of the permitted deduction?
An eligible educator can take the deduction. An eligible educator is a person who is a teacher, instructor, counselor, principal, or aide in K-12 who spends at least 900 hours per year on that job. The maximum deduction is $250. If a taxpayer is married filing jointly, and both individuals are eligible educators, each can take a deduction of up to $250, for a total maximum deduction of $500.
What expenses qualify as deductible educator expenses?
Qualified expenses are those for books, supplies, equipment and other materials used in the classroom. The expenses must be ordinary and necessary. Home schooling expenses and non-athletic supplies for health or physical education courses do not qualify as deductible expenses.
In the case of a joint return, what is the treatment of educator expenses?
If a taxpayer is married filing jointly, and both individuals are eligible educators, each can take a deduction of up to $250, for a total maximum deduction of $500.
Briefly explain the tax rules associated with the tuition and fees deduction.
Taxpayers can take an above-the-line AGI deduction for qualified tuition and related expenses paid during the year for the taxpayer, taxpayer's spouse, or a dependent. The deduction is a maximum of $4,000 but can be smaller if the modified AGI of the taxpayer exceeds certain limits. Expenses do not include insurance, medical expenses, room and board, transportation or other living expenses.
Mr. & Mrs. Chen paid tuition of $1,400 and required fees of $650 for their 25-year-old daughter who is attending State University, living on her own, and working 30 hours per week as a restaurant hostess. Their AGI is $50,000. The daughter paid for all of her other school and living expenses, which amounted to more than 50% of her total living expenses. What is the permitted amount of tuition and fees deduction for the Chens? Why?
Zero. The deduction is permitted for qualified expenses paid by the taxpayer, his or her spouse, or a dependent. Although it is not absolutely clear in the problem, the Chens' daughter is unlikely to be a dependent. In order to claim a dependency exemption, the Chen's would need to provide over 50% of their daughter's support. Since she is paying for all her other expenses, such an outcome is unlikely.
(Introduction) For AGI, or above-the-line, deductions:
a. Are determined by the taxpayer.
b. Are set by statute.
c. Increase tax liability.
d. Are reported in Schedule A.
Answer: b.
Feedback: For AGI, or above-the-line deductions, are deducted as an adjustment to AGI on page 1 of the Form 1040.
(Introduction) For AGI, or above-the-line, deductions:
a. Increase AGI.
b. Reduce tax credits.
c. Are available only for MFJ.
d. Can reduce overall tax liability.
Answer: d
Feedback: For AGI, or above-the-line deductions, reduce overall tax liability by decreasing AGI.
Student loan interest is reported on Form:
a. 1098-SA.
b. 1098-E.
c. 1099-S.
d. 1098-GA.
Answer: b
Feedback: The 1098-E details the amount of student loan interest paid in a given year.
Taxpayers eligible to take the student loan interest deduction do not include:
a. A student who is claimed as a dependent on another's return.
b. A self-supporting student.
c. The parents of a dependent student who took out the loan on their child's behalf.
d. A married student filing jointly.
Answer: a
Feedback: A person who is claimed as a dependent on another person's tax return is ineligible to take the student loan interest deduction.
In 2012 through 2015, Korey, who is single, borrowed a total of $25,000 for higher education expenses on qualified education loans. In 2016, while still living at home and being claimed by his parents as a dependent, he began making payments on the loan. The first year's interest on the loan was reported as $550 and his AGI for year was less than $65,000. The amount that Korey can claim on his tax return is:
a. $0.
b. $225.
c. $340.
d. $550.
Answer: a
Feedback: Because Korey is claimed as dependent on another's tax return, he cannot claim the deduction.
For 2016, the maximum aggregate annual contribution that a taxpayer, under age 55, can make to a Health Savings Account (HSA) for family coverage is:
a. $1,300.
b. $3,350.
c. $6,750.
d. $13,100.
Answer: c
Feedback: For someone over the age of 55, an additional $1,000 can be added to the allowable contribution.
To be eligible to fund a Health Savings Account (HSA), a taxpayer must meet which of the following criteria:
a. An employee (or spouse) who works for an employer with a high deductible health plan.
b. An uninsured employee who has purchased a high-deductible health plan on their own.
c. A self-employed individual.
d. Any of the above.
Answer: d
Feedback: In addition to one of the above three criteria, the individual cannot have other health insurance except for coverage for accidents, disability, dental care, vision care, long term care, or worker's compensation.
To be eligible to deduct moving expenses, a taxpayer:
a. Must meet the time test.
b. Must meet the distance test.
c. Must meet one of the change of job location, time, or distance tests.
d. Must meet all three of the change of job location, time, and distance tests.
Answer: d
Feedback: A taxpayer must meet all three tests to be eligible for the deduction; however all three tests do not have to be met simultaneously.
Deductible expenses for moving do not include:
a. The cost of transporting household goods.
b. Hotel costs while moving to the new location.
c. Meals incurred during the move.
d. Temporary storage of household goods for a limited time upon arrival at the new location.
Answer: c
Feedback: The IRS does not allow the deduction of meals as a moving expense, but there are other instances in the code, such as medical care expense, where the deduction for meals may be allowed.
To meet the distance test, the new job location must be:
a. 100 miles from the old job location.
b. At least 50 miles farther than the old residence was from the old job location.
c. At least 50 miles farther than the new residence is from the old job location.
d. 100 miles from the old residence.
Answer: b
Feedback: So if the distance between the old residence and old job is defined as X miles, the new job must be at least X + 50 miles from the old residence.
The deduction for half of the self-employment tax is:
a. Based on a total of 7.65% of FICA taxes.
b. Based on the gross earnings of the business.
c. Based on filing status.
d. Based on the net earnings of the business.
Answer: d
Feedback: Net earnings of the business represent revenues minus allowable deductible expenses.
As a for AGI deduction, self-employed health insurance premiums are deductible at:
a. 50%.
b. 70%.
c. 80%.
d. 100%.
Answer: d
Feedback: There are, however, two limitations that may limit the amount of the deduction. First, taxpayers cannot take a deduction for any amount in excess of net earnings from self-employment from the trade or business under which coverage is provided. Net earnings from self-employment are determined by reducing gross income by the regular expenses of the business as well as the deduction for one-half of the self-employment tax and any deduction for contributions to qualified retirement plans. The second limitation pertains to availability of other health insurance coverage. If the taxpayer is entitled to participate in any subsidized health plan maintained by any employer of the taxpayer or of the taxpayer's spouse, a deduction is not allowed.
Rick is a self-employed carpenter who had net earnings from self-employment of $3,500. He paid $325 per month for health insurance over the last year. Rick is entitled to a for AGI deduction for health insurance of:
a. $0.
b. $325.
c. $3,500.
d. $3,900.
Answer: c
Feedback: Rick can only deduct $3,500, instead of the $3,900 that he actually paid ($325 x 12 months) because of the income limitation.
Penalties for the early withdrawal of savings are reported by the financial institution on:
a. Box 2 of Form 1099-INT.
b. Form EWIP.
c. A letter of notification.
d. None of the above.
Answer: a
Roger is required under a 2015 divorce decree to pay $600 of alimony and $300 of child support per month for 12 years. In addition, Roger makes a voluntary payment of $100 per month. How much of each total monthly payment can Roger deduct in 2016?
a. $100.
b. $300.
c. $600.
d. $700.
Answer: c
Feedback: Alimony payments are deductible, but child support payments are not. In addition, the voluntary payment, since it is not required per the decree, is not deductible.
The Renfros were granted a decree of divorce in 2015. In accordance with the decree, Josh Renfro is to pay his ex-wife $24,000 a year until their only child, Evelyn now 10, turns 18, and then the payments will decrease to $14,000 per year. For 2016, how much can Josh deduct as alimony for the year?
a. $10,000.
b. $14,000.
c. $24,000.
d. None of the above.
Answer: b
Feedback: Any of the payments that relate to child support are not deductible. Because the payments decrease to $14,000 per year when the child turns 18, the amount of $10,000 is seemingly child support and not alimony.
At the beginning of June 2016, Julia left her husband and is currently living in an apartment. The couple has no children. At the end of the current year, no formal proceedings have occurred in relation to the separation or potential divorce. Julia has been making a $2,000 a month maintenance payment since moving out. How much can Julia deduct in total as alimony for 2016?
a. $0
b. $2,000.
c. $12,000.
d. $24,000.
Answer: a
Feedback: While it is admirable that Julia is making payments, none of it is deductible as alimony, since the payment is not a required result of a decree of separation or divorce.
What are some of the limitations concerning deductibility of student loan interest? Be specific and comprehensive.
Answer:
An individual may take a deduction for an amount equal to the interest paid by the taxpayer during the taxable year on any qualified education loan. Only the person legally obligated to make the interest payments can take the deduction. A person who is claimed as a dependent on another person's return, even though legally obligated to repay the loan, cannot claim the deduction, neither can persons whose filing status is married, filing separately.

Feedback: The amount of the deduction is limited to student loan interest of $2,500 per year. The deduction may be further limited based on the modified adjusted gross income of the taxpayer.
Discuss the characteristics of an eligible educational institution as it relates to the deductibility of student loan interest.
Answer:
An eligible institution is generally a postsecondary educational institution eligible to participate in the federal student loan program.

Feedback: This includes almost all four-year colleges and universities and two-year community colleges, and many trade and technical schools.
Cindy attended State University during 2011-2015. She lived at home and was claimed by her parents as a deduction during the entire duration of her education. She incurred education expenses of $10,000 during college of which $2,000 was paid for by scholarships. To finance her education, she borrowed $7,000 through a federal student loan program and borrowed another $3,000 from a local lending institution for educational purposes. After graduation, she married and moved with her husband to a distant city. In 2016, she incurred $700 of interest on the federal loans and $300 on the lending institution loan. She filed a joint return with her husband showing modified AGI of $128,000. What amount of student loan interest can Cindy and her husband deduct in 2016, if any?
Answer:
Generally, Cindy is permitted to take a for AGI deduction for student loan interest that she pays. She is the person obligated to pay the loan, amounts were actually paid, and she cannot be claimed as a dependent on someone else's tax return for 2016.

However, there is one limitation that applies in this instance. Qualified education expenses must be reduced by the amount of qualified scholarships. Since $2,000 of the total of $10,000 of education expenses was covered by a scholarship, only 80% of her borrowings went for qualified expenses so only 80% of the interest paid ($800) will qualify.

Feedback: The calculation is as follows:

$1,000 X 80% = $800

Cindy's allowed deduction is $800 as her modified AGI of $128,000 is below the $130,000 MAGI threshold for the reduction of student loan interest deductibility for MFJ.
If an employer contributes to an HSA on behalf of an employee,

a. Is the contribution deductible by the employee?


b. Is the payment considered income to the employee?
a.
Answer: No, because the employee paid nothing.
Feedback: There was no economic "sacrifice" on the part of the employee.

b.
Answer: No.
Feedback: The employer, however, is allowed a deduction for the contribution as the employer is the one who made the economic "sacrifice".
Fabian, a single account executive, was employed and resided in New Mexico. On July 1, 2016, his company transferred him to Florida. Fabian worked full-time for the entire year. During 2016, he incurred and paid the following expenses related to the move:

Pre-move house hunting costs: $1,500
Lodging and travel expenses (not meals) while moving 1,800
Costs of moving furniture and personal belongings 2,700

He did not receive reimbursement for any of these expenses from his employer; his AGI for the year was $85,500. What amount can Fabian deduct as moving expenses on his 2016 return?
Answer: $1,800 + $2,700 = $4, 500

Feedback: Fabian can deduct $4,500 in moving expenses. This includes the lodging and travel costs, and the costs of moving furniture and personal belongings but does not include the pre-move house hunting expenses. As moving expenses are an above-the-line deduction, his AGI was not a factor in the amount of the deduction.
In May 2016, Antonio graduated from UCLA with a degree in accounting and moved to Denver to look for work. Shortly after arriving in Denver, he obtained work as a staff accountant in a local CPA firm. In his move to Denver, Antonio incurred the following costs:
$275 in gasoline.
$250 for renting a truck from UPAYME rentals.
$100 for a tow trailer for his car.
$85 in food.
$25 in double espressos from Starbucks.
$300 for motel lodging on the way to Denver.
$405 for a previous plane trip to Denver to look for an apartment.
$175 in temporary storage costs for his collection of baseball memorabilia.

How much, if any, may Antonio take as a moving expense deduction on his 2016 tax return? Is that deduction subject to any conditions that could change its deductibility in the future?
Answer:
Antonio can deduct the following moving expenses for a total moving expense deduction of $1,100.

$275 in gasoline.
$250 for renting a truck from UPAYME rentals.
$100 for a tow trailer for his car.
$300 for motel lodging on the way to Denver.
$175 in temporary storage costs for his baseball memorabilia collection.

Feedback: None of the food expense items qualify for the deduction. House-hunting costs before the move are not deductible. It is important to note that Antonio is still obligated to meet the time test within a year of the move in order to sustain the deduction.
Are the moving expenses of other people besides the taxpayer deductible and, if so, what are the requirements for deductibility?
Answer:
Moving expenses of persons other than the taxpayer are permitted if the other persons are members of the taxpayer's household and both the old and new residences are the persons' principal place of abode.

Feedback: This situation occurs most often in the case of family members or other dependents that also move with the taxpayer. However, travel is limited to one trip per person, and only the expenses related to that one trip would be deductible.
Juan, who is single, is a self-employed carpenter and is also an employee of Frame It, Inc. His self-employment net income is $35,000, and he received a W-2 from Frame It for wages of $25,000. He is covered by his employer's pension plan, but his employer does not offer a health plan in which he could participate.

a. Up to how much of his self-employed health insurance premiums could he
deduct for this year, if any? Why?

b. How much of Juan's self-employment taxes would be deductible?
a.
Answer:
Juan can deduct up to 100% of his self-employed health insurance premiums.

Feedback: Of the two possible limitations in regards to this deduction, the only limitation that applies to Juan is that he can deduct premiums only up to $35,000, which is his net business income from self-employment.

b.
Answer:
Juan can deduct 50% of his self-employment taxes as an above-the-line deduction.

Feedback: Based on the information in the problem, Juan would also be eligible for creating a Health Savings Account (HSA).
Chantel has received a 1099-INT from her financial institution showing $85 in box 2 of the form. How should she handle this on her 2016 tax return and why?
Answer:
This $85 can be deducted as a "for AGI", or above the line deduction, on her Form 1040.

Feedback: The $85 in box 2 of Chantel's 1099-INT represents an early withdrawal penalty relating to a financial instrument, for example a certificate of deposit or CD.
Three types of payments are associated with a decree of separation or a divorce
a. What are those three payments?



b. Which one has a tax consequence?



c. What is the timing rule regarding the "recapture" period of those payments?
a.
Answer:
The three payments are alimony, child support, and property settlement.

b.
Answer:
Of the three payments, only alimony has a tax consequence. Alimony is deductible by the payer and must be included as income by the payee.

c.
Answer:
If alimony payments decrease sharply in the second or third year of payment, the payments may be subject to a recapture provision. The recapture rules effectively reclassify payments from alimony to a property settlement. These recapture rules do not apply after the third year of payment.

Feedback: The alimony recapture rules relate to the concept of "substance over form". They would effectively take the amounts that were deducted as alimony by the payer and reclassify them as income. The payee would then amend their return for a reduction of income for the year(s) in question.
Under the terms of a divorce decree executed May 1, 2016, Ahmed transferred a house worth $650,000 to his ex-wife, Farah, and was to make alimony payments of $3,000 per month. The property has a tax basis to Ahmed of $300,000.

a. How much of this must be reported on Farah's tax return?

b. Of that amount, how much is taxable gain or loss that Farah must recognize related to the transfer of the house?
a.
Answer:
Farah must report the alimony payments of $3,000 per month on her tax return.

Feedback: The transfer of the home would be considered a property settlement, not alimony.

b.
Answer:
The transfer of the house to Farah is a property settlement pursuant to a divorce. Therefore, she does not recognize any taxable gain on transfer of the house.

Feedback: Farah will potentially only recognize gain if she sells the home at some point for an amount greater than the transferred basis. As to any loss on a sale of a personal residence, none of that can be recognized.
Under the alimony recapture rules, what amounts are designated for recapture reclassification, and what are the tax consequences?
Answer:
The recapture rules effectively reclassify payments from alimony to a property settlement. If recapture is required, the recipient (who previously recorded income) gets to treat the recapture amount as a deduction and the payor (who previously recorded a deduction) must count the recapture as income.

Feedback: The alimony recapture rules relate to the concept of "substance over form". While the payments, or a portion of them, may be called alimony, but the form is something other than that, say child support or a property settlement, then the recapture rules would apply.
Indicate whether each of the following items is considered a for AGI, (above-the line) deduction for the 2016 tax year.
a. Student loan interest.
b. Gambling losses.
c. Early withdrawal penalty.
d. Child support payments.
e. Charitable contributions.
f. One-half of self-employment taxes.
g. Alimony.
h. Scholarships for tuition and books.
i. Moving expenses.
j. Property taxes.
k. Self-employed health insurance premiums.
Answer: For AGI deductions include items a, c, f, g, i, and k.

Feedback: Items b, e, and j are itemized deduction on the Schedule A. Items d and h do not have a tax effect and would not generally be reported on the return. If the scholarships did require an element of work, such as a teaching assistant position, then to that extent it would have to be included in income.
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