TAX 4001 Exam Questions with 100%
Correct Answers
Explain why Congress allows self-employed taxpayers to deduct the employer portion of their
self-employment tax. - ANSWER To put self-employed individuals on somewhat equal footing
with other employers that are allowed to deduct the employer's share of the social security tax.
Hence, self-employed taxpayers are allowed to deduct the employer's share of the self-
employment tax.
Using the Internal Revenue Code, describe two deductions for AGI that are not discussed in
this chapter. - ANSWER §62 is the quickest way to identify deductions for AGI, but several can
also be identified from the front of form 1040. Examples include the performing artist
deduction, deductions of business expenses for state and local officials, reforestation
expenses, and remitted jury duty pay.
Explain why Congress allows taxpayers to deduct interest forfeited as a penalty on the
premature withdrawal from a certificate of deposit. - ANSWER The full amount of the interest
income is included in gross income, and this deduction reduces the net interest income to the
amount actually received by the individual.
Describe the mechanical limitation on the deduction for interest on qualified educational loans.
- ANSWER The maximum deduction for interest expense on qualified education loans is the
amount of interest expense paid up to $2,500. However, the deduction is reduced (phased-out)
for taxpayers depending on the taxpayer's filing status and modified AGI. Specifically, the
deduction for interest on educational loans is subject to proportional phase-out over a range of
$15,000 ($30,000 for married filing jointly). The range begins for taxpayers at $65,000 of
modified AGI ($130,000 for MFJ) and ends at $80,000 of modified AGI ($160,000 for married
filing jointly). Modified AGI for this purpose is AGI before deducting interest expense on the
qualified education loans and before deducting qualified education expenses. Married
individuals who file separately are not allowed to deduct this expense under any circumstance.
Explain why the medical expense and casualty loss provisions are sometimes referred to as
"wherewithal" deductions and how this rationale is reflected in the limits on these deductions. -
,ANSWER These deductions are designed to reduce the tax burden on taxpayers whose
circumstances have involuntarily reduced their ability to pay. Both deductions are restricted to
expenses that exceed insurance reimbursements and a floor limit based upon AGI. These limits
ensure that taxpayers claiming the deduction have exceedingly large involuntary expenditures
as measured by their ability to pay.
Describe the type of medical expenditures that qualify for the medical expense deduction. Does
the cost of meals consumed while hospitalized qualify for the deduction? Do over-the-counter
drugs and medicines qualify for the deduction? - ANSWER Medical expenses include any
payments for the care, prevention, diagnosis, or cure of injury, disease, or bodily function that
are not reimbursed by health insurance. Included are the costs of prescription medicine, insulin,
and payments to doctors, dentists, and the like incurred by the taxpayer, taxpayer's spouse,
and dependents. Over-the-counter drugs and medicines do not qualify for the deduction.
Besides direct medical expenses, the deduction includes the cost of health insurance (if not
already deducted above the line by self-employed taxpayers or if not offset by a premium tax
credit under IRC Sec. 36B). Medical expenses also include long-term care services for disabled
spouses and dependents to the extent the costs (including meals and lodging) are attributable
to medical care. The cost of elective cosmetic surgery and over-the-counter drugs is not
deductible. The cost of meals and lodging qualify if incurred at a medical-care facility or hospital
and are incident to the care of the patient, but the cost of lodging is limited to $50 per eligible
person per night. The cost of travel for and essential to medical care, including lodging (still
limited to $50 per eligible person per night) is also deductible if the expense is not extravagant
and the travel has no significant element of personal pleasure.
Under what circumstances can a taxpayer deduct medical expenses paid for a member of his
family? Does it matter if the family member reports significant amounts of gross income and
cannot be claimed as a dependent? - ANSWER A taxpayer can deduct medical expenses
incurred for members of his family if they are dependents (i.e., either qualified children or
qualified relatives). For purposes of deducting medical expenses, a dependent need not
meet the gross income test (§213(a)).
What types of taxes qualify to be deducted as itemized deductions? Would a vehicle
registration fee qualify as a deductible tax? - ANSWER Taxes qualifying for this deduction
include state, local, and foreign income taxes, real estate taxes, and personal property taxes.
State and local sales taxes may also be deducted but only in lieu of state and local income taxes.
The deduction for sales tax can be based upon either the amount paid or the amount published
in the IRS tables (IRS Publication 600). Vehicle registration fees are not deductible (unless
calculated based on the value of the vehicle rather than its weight).
, Compare and contrast the limits on the deduction of interest on home acquisition indebtedness
versus home equity loans. Are these limits consistent with horizontal equity? Explain. - ANSWER
Taxpayers can deduct qualified residence interest defined as either (1) interest paid on a loan to
purchase or improve a residence (acquisition indebtedness) or (2) interest paid on a loan
secured by the residence but not used to purchase or improve the residence (home equity
loan). Interest paid can be deducted on $1 million of acquisition indebtedness and $100,000 of
home equity debt regardless of the rate of interest on the loan. These limits are consistent with
horizontal equity inasmuch as the limits treat taxpayers consistently across loan amounts.
However, the deduction for interest on acquisition indebtedness and home equity loans is
definitely not consistent with providing horizontal equity across homeowners and non-
homeowners.
Explain the argument that the deductions for charitable contributions and home mortgage
interest represent indirect subsidies for these activities. - ANSWER In each case, the deduction
reduces the after-tax cost of the activity, making it more likely that taxpayers will engage in
the activity. For example, contributions to charity reduce the cost of giving thereby indirectly
encouraging donations to charitable organizations.
Cash donations to charity are subject to a number of very specific substantiation requirements.
Describe these requirements and how charitable gifts can be substantiated. Describe the
substantiation requirements for property donations. - ANSWER Charitable contributions are only
deductible if substantiated with written records such as a cancelled check, bank record, or
a written communication from the charity showing the name of the charity and the date and
amount of the contribution. § 170(a)(1) and Reg § 1.170A-13(a)(1). Additional substantiation
is required for: contributions of $250 or more (§ 170(f)(8)), non-cash contributions exceeding
$500 (§170(f)(11)(B)), and contributions of cars, boats and planes (§ 170(f)(12)). For donations
of property, including clothing and household items, taxpayers should keep a written record
of the donation that includes a description of the property and its condition. Deductions are
not allowed for used property unless the property is in good condition. Taxpayers must keep a
contemporaneous, written acknowledgement from a charity for each deductible donation
(either money or property) of $250 or more. For contributions of property in excess of $500, a
description of the property must be attached to the tax return. A qualified appraisal of the
property must be attached with the return for donations of property with a value in excess of
$5,000.
Describe the conditions in which a donation of property to a charity will result in a charitable
contribution deduction of fair market value and when it will result in a deduction of the tax
Correct Answers
Explain why Congress allows self-employed taxpayers to deduct the employer portion of their
self-employment tax. - ANSWER To put self-employed individuals on somewhat equal footing
with other employers that are allowed to deduct the employer's share of the social security tax.
Hence, self-employed taxpayers are allowed to deduct the employer's share of the self-
employment tax.
Using the Internal Revenue Code, describe two deductions for AGI that are not discussed in
this chapter. - ANSWER §62 is the quickest way to identify deductions for AGI, but several can
also be identified from the front of form 1040. Examples include the performing artist
deduction, deductions of business expenses for state and local officials, reforestation
expenses, and remitted jury duty pay.
Explain why Congress allows taxpayers to deduct interest forfeited as a penalty on the
premature withdrawal from a certificate of deposit. - ANSWER The full amount of the interest
income is included in gross income, and this deduction reduces the net interest income to the
amount actually received by the individual.
Describe the mechanical limitation on the deduction for interest on qualified educational loans.
- ANSWER The maximum deduction for interest expense on qualified education loans is the
amount of interest expense paid up to $2,500. However, the deduction is reduced (phased-out)
for taxpayers depending on the taxpayer's filing status and modified AGI. Specifically, the
deduction for interest on educational loans is subject to proportional phase-out over a range of
$15,000 ($30,000 for married filing jointly). The range begins for taxpayers at $65,000 of
modified AGI ($130,000 for MFJ) and ends at $80,000 of modified AGI ($160,000 for married
filing jointly). Modified AGI for this purpose is AGI before deducting interest expense on the
qualified education loans and before deducting qualified education expenses. Married
individuals who file separately are not allowed to deduct this expense under any circumstance.
Explain why the medical expense and casualty loss provisions are sometimes referred to as
"wherewithal" deductions and how this rationale is reflected in the limits on these deductions. -
,ANSWER These deductions are designed to reduce the tax burden on taxpayers whose
circumstances have involuntarily reduced their ability to pay. Both deductions are restricted to
expenses that exceed insurance reimbursements and a floor limit based upon AGI. These limits
ensure that taxpayers claiming the deduction have exceedingly large involuntary expenditures
as measured by their ability to pay.
Describe the type of medical expenditures that qualify for the medical expense deduction. Does
the cost of meals consumed while hospitalized qualify for the deduction? Do over-the-counter
drugs and medicines qualify for the deduction? - ANSWER Medical expenses include any
payments for the care, prevention, diagnosis, or cure of injury, disease, or bodily function that
are not reimbursed by health insurance. Included are the costs of prescription medicine, insulin,
and payments to doctors, dentists, and the like incurred by the taxpayer, taxpayer's spouse,
and dependents. Over-the-counter drugs and medicines do not qualify for the deduction.
Besides direct medical expenses, the deduction includes the cost of health insurance (if not
already deducted above the line by self-employed taxpayers or if not offset by a premium tax
credit under IRC Sec. 36B). Medical expenses also include long-term care services for disabled
spouses and dependents to the extent the costs (including meals and lodging) are attributable
to medical care. The cost of elective cosmetic surgery and over-the-counter drugs is not
deductible. The cost of meals and lodging qualify if incurred at a medical-care facility or hospital
and are incident to the care of the patient, but the cost of lodging is limited to $50 per eligible
person per night. The cost of travel for and essential to medical care, including lodging (still
limited to $50 per eligible person per night) is also deductible if the expense is not extravagant
and the travel has no significant element of personal pleasure.
Under what circumstances can a taxpayer deduct medical expenses paid for a member of his
family? Does it matter if the family member reports significant amounts of gross income and
cannot be claimed as a dependent? - ANSWER A taxpayer can deduct medical expenses
incurred for members of his family if they are dependents (i.e., either qualified children or
qualified relatives). For purposes of deducting medical expenses, a dependent need not
meet the gross income test (§213(a)).
What types of taxes qualify to be deducted as itemized deductions? Would a vehicle
registration fee qualify as a deductible tax? - ANSWER Taxes qualifying for this deduction
include state, local, and foreign income taxes, real estate taxes, and personal property taxes.
State and local sales taxes may also be deducted but only in lieu of state and local income taxes.
The deduction for sales tax can be based upon either the amount paid or the amount published
in the IRS tables (IRS Publication 600). Vehicle registration fees are not deductible (unless
calculated based on the value of the vehicle rather than its weight).
, Compare and contrast the limits on the deduction of interest on home acquisition indebtedness
versus home equity loans. Are these limits consistent with horizontal equity? Explain. - ANSWER
Taxpayers can deduct qualified residence interest defined as either (1) interest paid on a loan to
purchase or improve a residence (acquisition indebtedness) or (2) interest paid on a loan
secured by the residence but not used to purchase or improve the residence (home equity
loan). Interest paid can be deducted on $1 million of acquisition indebtedness and $100,000 of
home equity debt regardless of the rate of interest on the loan. These limits are consistent with
horizontal equity inasmuch as the limits treat taxpayers consistently across loan amounts.
However, the deduction for interest on acquisition indebtedness and home equity loans is
definitely not consistent with providing horizontal equity across homeowners and non-
homeowners.
Explain the argument that the deductions for charitable contributions and home mortgage
interest represent indirect subsidies for these activities. - ANSWER In each case, the deduction
reduces the after-tax cost of the activity, making it more likely that taxpayers will engage in
the activity. For example, contributions to charity reduce the cost of giving thereby indirectly
encouraging donations to charitable organizations.
Cash donations to charity are subject to a number of very specific substantiation requirements.
Describe these requirements and how charitable gifts can be substantiated. Describe the
substantiation requirements for property donations. - ANSWER Charitable contributions are only
deductible if substantiated with written records such as a cancelled check, bank record, or
a written communication from the charity showing the name of the charity and the date and
amount of the contribution. § 170(a)(1) and Reg § 1.170A-13(a)(1). Additional substantiation
is required for: contributions of $250 or more (§ 170(f)(8)), non-cash contributions exceeding
$500 (§170(f)(11)(B)), and contributions of cars, boats and planes (§ 170(f)(12)). For donations
of property, including clothing and household items, taxpayers should keep a written record
of the donation that includes a description of the property and its condition. Deductions are
not allowed for used property unless the property is in good condition. Taxpayers must keep a
contemporaneous, written acknowledgement from a charity for each deductible donation
(either money or property) of $250 or more. For contributions of property in excess of $500, a
description of the property must be attached to the tax return. A qualified appraisal of the
property must be attached with the return for donations of property with a value in excess of
$5,000.
Describe the conditions in which a donation of property to a charity will result in a charitable
contribution deduction of fair market value and when it will result in a deduction of the tax
