QUESTION: 5

In 19X4, Smith, a divorced person, provided over one half the support for his widowed mother, Ruth, and his son, Clay, both of whom are U.S. citizens. During 19X4, Ruth did not live with Smith. She received $9,000 in Social Security benefits. Clay, a 25 year-old full-time graduate student, and his wife lived with Smith. Clay had no income but filed a joint return for 19X4, owing an additional $500 in taxes on his wife's income. How many exemptions was Smith entitled to claim on his 19X4 tax return?

4
3
2
1

Answer(s): C

Explanation:

Choice "c" is correct. Smith is entitled to an exemption for himself. He is also entitled to an exemption for his mother Ruth (qualifying relative). Ruth has $9,000 in Social Security payments during 19X4, but since that is her only income, the Social Security is not taxable, and nontaxable income does not count in calculating whether an exemption can be taken for a dependent. Clay cannot be taken as a dependent because he filed a joint return with his wife. Since the joint return was filed for a purpose other than simply claiming a refund, the joint return prevents Smith from claiming an exemption for Clay. An exemption cannot be taken for Clay's wife because she filed a joint return with Clay. Smith is entitled to two exemptions.

Choice "a" is incorrect. Clay cannot be taken as a dependent because he filed a joint return with his wife. Since the joint return was filed for a purpose other than simply claiming a refund, the joint return prevents Smith from claiming an exemption for Clay. An exemption cannot be taken for Clay's wife because she filed a joint return with Clay.

Choice "b" is incorrect. Clay cannot be taken as a dependent because he filed a joint return with his wife. Since the joint return was filed for a purpose other than simply claiming a refund, the joint return prevents Smith from claiming an exemption for Clay. An exemption cannot be taken for Clay's wife because she filed a joint return with Clay.

Choice "d" is incorrect. Smith is entitled to an exemption for his mother, Ruth. Ruth has $9,000 in Social Security payments during 19X4, but because that is her only income, the Social Security income is not taxable, and nontaxable income does not count in calculating whether an exemption can be taken for a dependent.

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QUESTION: 6

Darr, an employee of ABC corporation, is not a shareholder. Which of the following would be included in a taxpayer's gross income?

Employer-provided medical insurance coverage under a health plan.
A $10,000 gift from the taxpayer's grandparents.
The fair market value of land that the taxpayer inherited from an uncle.
The dividend income on shares of stock that the taxpayer received for services rendered.

Answer(s): D

Explanation:

Choice "d" is correct. An individual receiving common stock for services rendered must recognize the fair market value as ordinary income. Any dividends received on that stock would also result in income recognition. Choice "a" is incorrect. Employer-provided medical insurance is a tax-free fringe benefit.
Choices "b" and "c" are incorrect. Gifts and inheritances are both tax-free to the recipient. (Remember tax is often paid by the person giving the gift or the estate at death.)

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QUESTION: 7

Adams owns a second residence that is used for both personal and rental purposes. During 2001,
Adams used the second residence for 50 days and rented the residence for 200 days. Which of the following statements is correct?

Depreciation may not be deducted on the property under any circumstances.
A rental loss may be deducted if rental-related expenses exceed rental income.
Utilities and maintenance on the property must be divided between personal and rental use.
All mortgage interest and taxes on the property will be deducted to determine the property's net income or loss.

Answer(s): C

Explanation:

Choice "c" is correct. Because the second property was personally used more than 14 days, any net loss from the rental of the property will be disallowed.
All related expenses must be prorated between the personal use portion and the rental activity portion. Prorated depreciation is permitted for the rental activity.

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QUESTION: 8

Baum, an unmarried optometrist and sole proprietor of Optics, buys and maintains a supply of eyeglasses and frames to sell in the ordinary course of business. In 1999, Optics had $350,000 in gross business receipts and its year-end inventory was not subject to the uniform capitalization rules. Baum's 1999 adjusted gross income was $90,000 and Baum qualified to itemize deductions. During 1999, Baum recorded the following information: Business expenses:

What amount should Baum report as 1999 net earnings from self-employment?

$243,250
$252,000
$273,000
$281,750

Answer(s): D

Explanation:

Choice "d" is correct. Baum should report $281,750 as 1999 net earnings from self-employment (line 12 of the Form 1040), calculated as follows:

Choices "a", "b", and "c" are incorrect. Self-employment tax and self-employment health insurance expenses are adjustments from total gross income. They are not deducted from self-employment earnings (i.e., not reported net on line 12 of the Form 1040).

Note: There are many distracters in this question, all relating to items that are either deductible as part of itemized deductions or not deductible. Be careful to read the requirement of the question before spending unnecessary time on the question. The statement that Baum's year-end inventory was not subject to the uniform capitalization rules is a distracter as well. There is not enough information given in the facts to apply the rules if he had been subject to them.

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