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Chapter 4: Study Questions
1. Joan loaned Marie $5,000 with the agreement that Marie would repay the loan with interest.
Marie made one monthly payment to Joan in December in the amount of $306 (of which $28
has been designated as interest). What is the appropriate way to report this income?
a) Joan is not required to report the income at all.
b) Joan must report the $28 payment as interest income and the remaining $278 as other
income.
c) Joan must report the $28 payment as interest income, and the remaining $278 is not
taxable.
d) Joan must report the entire $306 payment as interest income.
a) This answer is incorrect. Joan is required to report the $28 of interest income.
b) This answer is incorrect. The $278 return of capital is not taxable.
c) Correct. Of the $306 payment, only the amount designated as interest ($28) would
be reported as interest income. The difference in the amount of $278 would be
considered a return of principal, which is not taxable. Pages 4.1-4.6, 4.10-4-13
d) This answer is incorrect. Only a portion of the $306 is considered interest income.
2. Walter received interest from several different sources. He’s not sure which of these he needs
to report as taxable income. Which of the following types of interest is nontaxable?
a) Interest income earned from a checking account
b) Interest income earned from a certificate of deposit
c) Interest income received from an installment sale
d) Interest from municipal bonds
a) This answer is incorrect. Interest income earned from a checking account is considered
taxable income.
b) This answer is incorrect. Interest income earned from a certificate of deposit is considered
taxable income.
c) This answer is incorrect. Interest income received from an installment sale is considered
taxable income.
d) Correct. Municipal bonds are not taxable. Page 4.9
3. Walter received interest from his savings accounts in the amount of $1,621 and municipal bond
interest in the amount of $375. How should Walter report his municipal bond interest?
a) On Form 1040, line 2a
b) On Schedule B, Part I and Form 1040, line 2a
c) On Form 1040, line 2b
d) He is not required to report the municipal bond interest.
a) Correct. Municipal bond interest is considered tax-exempt interest on the federal tax
return. The amount should be reported directly on line 2a of Form 1040. Page 4.9
b) This answer is incorrect. Tax-exempt interest should not be reported on Schedule B; it is
reported on Form 1040, line 2a.
c) This answer is incorrect. Line 2b is where taxable interest is recorded. Tax-exempt interest
is recorded on line 2a of Form 1040.
d) This answer is incorrect. Although municipal bond interest is not taxable, it is required to
be reported on Form 1040, line 2a.
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4. George received significant dividend income during the tax year. How should he report the
dividend income if he has ordinary dividend income is in excess of $1,500?
a) On Schedule B and Form 1040, line 3a
b) On Form 1040, line 3a
c) On Form 1040, line 3b
d) On Schedule B and Form 1040, line 3b
a) This answer is incorrect. Although George must report his ordinary dividend income on
Schedule B because it is greater than $1,500, ordinary dividends are also reported on line
3b. Qualified dividends are reported on line 3a.
b) This answer is incorrect. George must report his ordinary dividend income on Schedule B
because it is greater than $1,500. Line 3a is for reporting qualified dividends, not ordinary
dividends. Ordinary dividends are reported on line 3b.
c) This answer is incorrect. Ordinary dividend income is reported on Form 1040, line 3b.
However, since the ordinary dividends are greater than $1,500, George must also report
the ordinary dividends on Schedule B.
d) Correct. Since George’s ordinary dividend income is greater than $1,500, he is
required to report it on both Schedule B and Form 1040, line 3b. Pages 4.14-4.15
5. Rick uses the cash method of accounting and must report his interest income when it is
constructively received. When is Rick’s interest income considered to be constructively
received?
a) When the income has been credited to his account
b) When he receives a statement
c) When he withdraws or uses the interest income
d) At the end of the tax year
a) Correct. Income is constructively received when it is credited to the taxpayer’s
account or made available. The taxpayer does not need to have physical possession
of the money. Page 4.2
b) This answer is incorrect. The receipt of a statement is not constructive receipt of income.
c) This answer is incorrect. The taxpayer does not need to have physical possession of the
money in order for the income to be constructively received.
d) This answer is incorrect. The taxpayer does not need to wait until the end of the tax year
to have constructive receipt.
6. James, the new tax preparer, has new clients with original issue discount (OID) interest, so he
researches the topic. Which of the following is an example of an instrument that pays no interest
before maturity?
a) Treasury notes
b) Zero-coupon bonds
c) Education bonds
d) Certificates of deposits
a) This answer is incorrect. Treasury notes pay interest every six months.
b) Correct. Zero-coupon bonds are an example of an instrument that pays no interest
before maturity. All instruments that pay no interest before maturity are presumed
to be issued at a discount, as interest accrues over the term of the debt instrument.
Page 4.6
c) This answer is incorrect. Education bonds pay interest before their maturity.
d) This answer is incorrect. Certificates of deposit pay interest before their maturity.
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7. Rudy received $1,780 in interest income from CDs, $325 in dividend income from a federal
credit union, and $280 in tax-exempt interest from local municipal bonds. How should Rudy
report the income?
a) Report $2,105 on Form 1040, line 2b; and report $280 on Form 1040, line 2a.
b) Report $1,780 on Form 1040, line 2b, $280 on Form 1040, line 2a; and report $325 on
Form 1040, line 3b.
c) Report $2,105 on Schedule B, Part I and Form 1040, line 2b; and report $280 on Form
1040, line 2a.
d) Report $1,780 on Schedule B, Part I and Form 1040, line 2b; report $325 on Schedule B,
Part II and Form 1040, line 3b; and report $280 on Form 1040, line 2a.
a) This answer is incorrect. The taxable interest income is greater than $1,500, so it must also
be reported on Schedule B.
b) This answer is incorrect. These are not the correct lines to report this income.
c) Correct. Dividend income from the federal credit union is classified as interest
income. Since the total interest income is greater than $1,500, Schedule B is
required. Report the taxable income on line 2b of Form 1040 and the tax-exempt
interest income on line 2a of Form 1040. Pages 4.2, 4.10, 4.14
d) This answer is incorrect. Credit union dividends are classified as interest income.
8. Amy is a single mother. She redeemed qualified U.S. savings bonds during the year to pay for
her dependent son’s qualified education expenses. She wants to know if she will be taxed on
the interest earned. Her modified adjusted gross income (MAGI) is $97,350. Which of the
following statements is correct?
a) She is allowed to exclude the full amount of the interest earned, and she must complete
and attach Form 8815 to her return.
b) She is allowed to exclude part of the interest earned, and she must complete and
attach Form 8815 to her return.
c) She is not allowed to exclude any of the interest earned.
d) She is allowed to exclude part of the interest earned, and she does not need to complete
Form 8815.
a) This answer is incorrect. The amount of the interest exclusion may be limited depending
on the taxpayer’s MAGI.
b) Correct. Her MAGI is between $91,850 and $106,850. She is allowed to exclude a
portion of the interest earned. Pages 4.5-4.6
c) This answer is incorrect. She is allowed to exclude some of the interest received from the
U.S. savings bonds since she paid qualified education expenses during the year, and her
MAGI does not exceed the allowable limit.
d) This answer is incorrect. The education savings bond interest exclusion must be reported
on Form 8815.
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Chapter 4: Study Questions
1. Joan loaned Marie $5,000 with the agreement that Marie would repay the loan with interest.
Marie made one monthly payment to Joan in December in the amount of $306 (of which $28
has been designated as interest). What is the appropriate way to report this income?
a) Joan is not required to report the income at all.
b) Joan must report the $28 payment as interest income and the remaining $278 as other
income.
c) Joan must report the $28 payment as interest income, and the remaining $278 is not
taxable.
d) Joan must report the entire $306 payment as interest income.
a) This answer is incorrect. Joan is required to report the $28 of interest income.
b) This answer is incorrect. The $278 return of capital is not taxable.
c) Correct. Of the $306 payment, only the amount designated as interest ($28) would
be reported as interest income. The difference in the amount of $278 would be
considered a return of principal, which is not taxable. Pages 4.1-4.6, 4.10-4-13
d) This answer is incorrect. Only a portion of the $306 is considered interest income.
2. Walter received interest from several different sources. He’s not sure which of these he needs
to report as taxable income. Which of the following types of interest is nontaxable?
a) Interest income earned from a checking account
b) Interest income earned from a certificate of deposit
c) Interest income received from an installment sale
d) Interest from municipal bonds
a) This answer is incorrect. Interest income earned from a checking account is considered
taxable income.
b) This answer is incorrect. Interest income earned from a certificate of deposit is considered
taxable income.
c) This answer is incorrect. Interest income received from an installment sale is considered
taxable income.
d) Correct. Municipal bonds are not taxable. Page 4.9
3. Walter received interest from his savings accounts in the amount of $1,621 and municipal bond
interest in the amount of $375. How should Walter report his municipal bond interest?
a) On Form 1040, line 2a
b) On Schedule B, Part I and Form 1040, line 2a
c) On Form 1040, line 2b
d) He is not required to report the municipal bond interest.
a) Correct. Municipal bond interest is considered tax-exempt interest on the federal tax
return. The amount should be reported directly on line 2a of Form 1040. Page 4.9
b) This answer is incorrect. Tax-exempt interest should not be reported on Schedule B; it is
reported on Form 1040, line 2a.
c) This answer is incorrect. Line 2b is where taxable interest is recorded. Tax-exempt interest
is recorded on line 2a of Form 1040.
d) This answer is incorrect. Although municipal bond interest is not taxable, it is required to
be reported on Form 1040, line 2a.
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4. George received significant dividend income during the tax year. How should he report the
dividend income if he has ordinary dividend income is in excess of $1,500?
a) On Schedule B and Form 1040, line 3a
b) On Form 1040, line 3a
c) On Form 1040, line 3b
d) On Schedule B and Form 1040, line 3b
a) This answer is incorrect. Although George must report his ordinary dividend income on
Schedule B because it is greater than $1,500, ordinary dividends are also reported on line
3b. Qualified dividends are reported on line 3a.
b) This answer is incorrect. George must report his ordinary dividend income on Schedule B
because it is greater than $1,500. Line 3a is for reporting qualified dividends, not ordinary
dividends. Ordinary dividends are reported on line 3b.
c) This answer is incorrect. Ordinary dividend income is reported on Form 1040, line 3b.
However, since the ordinary dividends are greater than $1,500, George must also report
the ordinary dividends on Schedule B.
d) Correct. Since George’s ordinary dividend income is greater than $1,500, he is
required to report it on both Schedule B and Form 1040, line 3b. Pages 4.14-4.15
5. Rick uses the cash method of accounting and must report his interest income when it is
constructively received. When is Rick’s interest income considered to be constructively
received?
a) When the income has been credited to his account
b) When he receives a statement
c) When he withdraws or uses the interest income
d) At the end of the tax year
a) Correct. Income is constructively received when it is credited to the taxpayer’s
account or made available. The taxpayer does not need to have physical possession
of the money. Page 4.2
b) This answer is incorrect. The receipt of a statement is not constructive receipt of income.
c) This answer is incorrect. The taxpayer does not need to have physical possession of the
money in order for the income to be constructively received.
d) This answer is incorrect. The taxpayer does not need to wait until the end of the tax year
to have constructive receipt.
6. James, the new tax preparer, has new clients with original issue discount (OID) interest, so he
researches the topic. Which of the following is an example of an instrument that pays no interest
before maturity?
a) Treasury notes
b) Zero-coupon bonds
c) Education bonds
d) Certificates of deposits
a) This answer is incorrect. Treasury notes pay interest every six months.
b) Correct. Zero-coupon bonds are an example of an instrument that pays no interest
before maturity. All instruments that pay no interest before maturity are presumed
to be issued at a discount, as interest accrues over the term of the debt instrument.
Page 4.6
c) This answer is incorrect. Education bonds pay interest before their maturity.
d) This answer is incorrect. Certificates of deposit pay interest before their maturity.
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7. Rudy received $1,780 in interest income from CDs, $325 in dividend income from a federal
credit union, and $280 in tax-exempt interest from local municipal bonds. How should Rudy
report the income?
a) Report $2,105 on Form 1040, line 2b; and report $280 on Form 1040, line 2a.
b) Report $1,780 on Form 1040, line 2b, $280 on Form 1040, line 2a; and report $325 on
Form 1040, line 3b.
c) Report $2,105 on Schedule B, Part I and Form 1040, line 2b; and report $280 on Form
1040, line 2a.
d) Report $1,780 on Schedule B, Part I and Form 1040, line 2b; report $325 on Schedule B,
Part II and Form 1040, line 3b; and report $280 on Form 1040, line 2a.
a) This answer is incorrect. The taxable interest income is greater than $1,500, so it must also
be reported on Schedule B.
b) This answer is incorrect. These are not the correct lines to report this income.
c) Correct. Dividend income from the federal credit union is classified as interest
income. Since the total interest income is greater than $1,500, Schedule B is
required. Report the taxable income on line 2b of Form 1040 and the tax-exempt
interest income on line 2a of Form 1040. Pages 4.2, 4.10, 4.14
d) This answer is incorrect. Credit union dividends are classified as interest income.
8. Amy is a single mother. She redeemed qualified U.S. savings bonds during the year to pay for
her dependent son’s qualified education expenses. She wants to know if she will be taxed on
the interest earned. Her modified adjusted gross income (MAGI) is $97,350. Which of the
following statements is correct?
a) She is allowed to exclude the full amount of the interest earned, and she must complete
and attach Form 8815 to her return.
b) She is allowed to exclude part of the interest earned, and she must complete and
attach Form 8815 to her return.
c) She is not allowed to exclude any of the interest earned.
d) She is allowed to exclude part of the interest earned, and she does not need to complete
Form 8815.
a) This answer is incorrect. The amount of the interest exclusion may be limited depending
on the taxpayer’s MAGI.
b) Correct. Her MAGI is between $91,850 and $106,850. She is allowed to exclude a
portion of the interest earned. Pages 4.5-4.6
c) This answer is incorrect. She is allowed to exclude some of the interest received from the
U.S. savings bonds since she paid qualified education expenses during the year, and her
MAGI does not exceed the allowable limit.
d) This answer is incorrect. The education savings bond interest exclusion must be reported
on Form 8815.
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