Midterm 1
Answer Key
BA 128 Professor Alan Cerf
Prepared by: Celia Poon
1. Ans. B - All medical expenses are deductible as from AGI itemized deduction to the extent
that it exceeds 7.5% of AGI. Sum = $3110. Allowable deduction is 7.5% of AGI
(0.075*3200 = $2400) i.e. 3110-2400 = $710.
2. Ans. D – Interest on money borrowed to buy stock is considered as investment interest.
Investment interest is deductible to the extent of investment income and the excess is allowed
to carry forward. Interest on a personal car loan and credit cards are not deductible. Interest
on a personal residence mortgage is deductible up to $1million of acquisition indebtedness
and $100,000 of home equity loan.
3. Ans. B - Investment interest is deductible to the extent of investment income. Therefore only
$1800 is deductible out of the $2190. Credit card interest is not deductible from AGI.
Interest on loans used for a business and interest on a credit card used for business are both
for AGI deductions. The total amount deductible for itemized is $8900+$1800 = $10700.
4. Ans. A – Real estate taxes on rental property is considered as passive activity expenses (for
AGI deductions), federal income taxes and social security taxes for household help are not
deductible. Therefore, the total amount of itemized deductions is $4500+$1500+$500 =
$6500.
5. Ans. C – Hobby expenses are deductible to the extent of hobby income. In this problem,
interest on home equity loan is also part of hobby expenses and is considered as tier 1
expenses. The rest of the expenses $8500 is considered as tier 2 expenses and will be
deducted up to $4500 as miscellaneous deduction subject to the 2% AGI limitation.
Therefore Paul’s taxable income is calculated as follows:
AGI: Salary
Hobby Income
Total AGI
$95000
$ 5000
$100000
Itemized deduction
Interest on loan to purchase home
Taxes on home
Interest on home equity loan to hobby assets
Expenses on hobby (4500- 2%*100,000)
$
$
$
$
Personal exemption (1997)
$ 2650
Taxable Income
$83850
8000
2500
500
2500
6. Ans. C. The transaction is considered as wash sales. However, only 40 shares are purchased.
Therefore, disallowed loss is only 40% of the loss of $1200 ($2000-$800) which is $480.
Recognized loss is thus $720.
7. Ans. A – Fines and Gifts to Government Inspection Officials are not deductible as business
expenses (for AGI deductions). Therefore, only $100,000+$15,000+$10,000 = $125,000 is
deductible.
Midterm 1
Answer Key
BA 128 Professor Alan Cerf
Prepared by: Celia Poon
8. Ans. C – Unreimbursed professional dues and subscriptions to newsletters recommending
stocks (investment expenses) are all miscellaneous itemized deductions. Therefore, Susan’s
AGI is calculated as follows:
Gross Salary
Rent received from tenant
Dividends received
$40000
$ 6000
$ 8000
For AGI deductions
Taxes, interest and repair expenses on rental house $ 2000
Depreciation expense on rental house
$ 3000
AGI
$49000
9. Ans. B – Inherited property’s adjusted basis is the FMV at the decedent’s date of death.
Therefore, the adjusted basis for Bob is $1000,000. Therefore, the capital gain is $200,000
when Bob sells it later. Capital gain of inherited property is always long term regardless of
holding period. Problem 5-74, I5-15
10. Ans. B – NSTCL and net against NLTCG. From the STCL of $7200 (10,000-2,800), $3000
can be taken as an offset against ordinary income, the rest, $4,200 is carried forward as STCL
the following year.
11. Ans. C – The sale of the asset generates a Long term capital gain of $10,000 (11,000 – 1000
adjusted basis), long term capital gain is taxed at a maximum tax rate of 20%. Therefore the
tax liability for Everett with regards to this gain is $10,000 * 0.2 = $2000.
12. Ans. A – Stock dividend increases the number of shares by 20%, therefore the respective
calculations for the two group of stocks are as follows:
2/15 shares 150 shares @ $60 = $9000. After stock dividend, number of shares = 150*1.2 =
180 shares, basis of shares = $9000/180 = $50 per share
5/15 shares 50 shares @$90 = $4500. After stock dividend, number of shares = 50*1.2 = 60
shares, basis of shares = $4500/60 = $75 per share
13. Ans. B – Adjusted basis for the donee in the transfer of gifts depends on the donor’s adjusted
basis vs. the FMV of the gift. In this question, the FMV of the necklace ($46,000) is greater
than the adjusted basis for the donor ($12,000), so the adjusted basis of the donee is the
donor’s which is $12000. However, the gift taxes paid will also increase the adjusted basis.
The formula to calculate the amount to increase the adjusted basis is as follows:
(46000-12000)/36000 * 9000 = 8500
The total adjusted basis = 12,000 + 8,500 = $20500.
14. Ans. B – The basis of an asset includes money and FMV of property received, any liability
assumed, and the costs of acquiring the asset. Therefore, Diane’s basis in the asset is the sum
of $40,000+$10,000+$1,000+$500+$900 = $52,400.
15. Ans. B – Assuming that the fringe benefit is received in cash, Bob will have to pay an extra
$28 ($100* 0.28) of taxes. Therefore, the after-tax saving is $28.
Midterm 1
Answer Key
BA 128 Professor Alan Cerf
Prepared by: Celia Poon
16. Ans. D – Discounts on services for employee fringe benefits is only up to 20%.
17. Ans. C – For employees other than key employees, group term coverage in excess of $50,000
must include an amount established by regulations called the uniform one-month group term
premiums per $1000 life insurance coverage. The problem specify $1 per $1000 in excess
per month. Therefore, the calculation for the amount to include = $50,000 (amount in
excess)*$1*12/1000 = $600.
18. Ans. D – Tuition, books, supplies and equipment is deductible. The $1500 room and board
and the $1700 grading compensation cannot be excluded despite the fact that the work was a
requirement by scholarship. Therefore $3200 cannot be excluded.
19. Ans. B
Provisional Income
Taxable Interest
$5000
Taxable Dividends
$7000
Taxable pension
$13000
AGI (excluding SS benefits)
$25000
Plus
Tax exempt interest
$ 4000
50% of SS benefits
$8000
Provisional Income
$37000
Taxable SS benefits = the lesser of 50% of SS benefits ($8000) or 50% of (37000-32000) =
$2500.
20. Ans. B – Interest on county bonds is considered municipal bonds, so it is excluded from
income. Interest credited to Ms. Guy’s account last year is considered income last year, not
this year. Therefore, the total amount of gross income = $57000+1865 = $58,865.
21. Ans. B – For accrual method taxpayer, prepaid income for services performed next year do
not need to include that amount in income (See PI3-11 – exceptions). The rest of the mount
$6000+$5000 = $11,000 are money collected for services performed this year. Therefore, the
amount needs to be included in income.
22. Ans. D – Although the paycheck is received by the employee, funds are actually not available
because the employer does not have funds in the bank to make the payment.
23. No answer is available. Assumption made is that Sonya’s college student status implies that
she is a full time student. Since her parents provide more than half of her support, they are
able to claim her as a dependent. To be claimed as a dependent, the dependent
himself/herself cannot claim a personal exemption and its standard deduction amount is
limited to the greater of earned income +$250 or $700. In Sonya’s case, her standard
deduction is $4250. Her AGI is $4000+$600 = $4600. Therefore, her taxable income is
$4600-$4250 = $350.
24. No answer is available.
Total personal and dependency exemption = 2700*3 = $8100
Phased out amount (250,000-186800)= 63200
Points of excess amount per $2500 = 63200/2500 = 26
% of reduction = 26*2% = 52%
Amount of exemption allowable = 48%*8100 = $3888