TAX 4001 Exam 2 with 100% Correct Answers
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
basis of the property. - ANSWER Taxpayers deduct the fair market value of property (noncash)
donations when they donate:
(1) a capital asset that has appreciated in value (the value is greater than the basis of the
property) and the taxpayer has owned the asset for more than a year before donating it
(but see exceptions below), or
(2) appreciated business assets (value greater than basis) the taxpayer owned for more than a
year before donating but only to the extent that the gain on the asset would not be treated
as ordinary income if it had been sold.
However, the deduction for an appreciated capital asset that is tangible, personal property
is limited to the adjusted basis of the property if the charity uses the property for a purpose
unrelated to its charitable purpose.
Taxpayers donating ordinary income property (or capital loss property) deduct the lesser of (1)
the fair market value of the property and (2) the adjusted basis of the property. Thus when the
value of ordinary income property (or capital loss property) is less than the basis, taxpayers
deduct the value.
Thus, taxpayers deduct the basis of the property when they contribute:
ordinary income property that has appreciated in value.
capital gain property donated to private nonoperating foundations (other than stock).
capital gain property consisting of tangible personal property and the charity uses the property
(and the taxpayer should have reasonably expected that) for a purpose unrelated to the
reason it is a charity.
,appreciated business assets held more than a year to the extent that the gain would be
recaptured as ordinary income under the depreciation recapture rules.
Describe the type of event that qualifies as a casualty for tax purposes. - ANSWER A casualty is
defined as an unexpected, unforeseen, or unusual event such as a "fire, storm, or shipwreck"
or loss from theft.
A casualty loss from the complete destruction of a personal asset is limited to the lesser of fair
market value or the property's adjusted basis. Explain the rationale for this rule as opposed to
just allowing a deduction for the basis of the asset. - ANSWER The loss from any specific event is
limited to the lesser of the economic loss or the tax basis (cost) of the asset to prevent the
deduction of otherwise nondeductible personal losses. If the basis (cost) of the asset was
always allowed for a personal casualty loss deduction, then this would have the effect of
allowing a deduction for the decline in the value of the asset prior to the casualty (assuming
that original cost exceeds the value of the asset).
This week Jim's residence was heavily damaged by a storm system that spread destruction
throughout the region. While Jim's property insurance covers some of the damage, there is a
significant amount of uninsured loss. The governor of Jim's state has requested that the
president declare the region a federal disaster area and provide federal disaster assistance.
Explain to Jim the income tax implications of such a declaration and any associated tax
planning possibilities. - ANSWER Under IRC §165(i), individuals who incur a disaster loss are
subject to the regular casualty loss floor limits ($100/10 percent of AGI), but they may elect to
claim a disaster loss for the tax year before the loss occurred (e.g., by filing an amended return
if the original return has been filed). This deduction could accelerate the tax benefit of the loss
(and any attendant refund), but also allow the taxpayer to choose the year with the most
attractive tax outcome (in terms of AGI limits, other casualty losses (or gains), and marginal tax
rate).
Describe the types of expenses that constitute miscellaneous itemized deductions and explain
why these expenses rarely produce any tax benefits. - ANSWER Miscellaneous itemized
deductions consist of employee business expenses (not reimbursed under an accountable plan),
investment expenses (not related to rental or royalty activities), and tax preparation fees. These
deductions must be reduced by two percent of AGI before the deductions can be combined
with other itemized deductions. This floor limit makes it unlikely these itemized deductions will
generate any tax benefit.
, Explain why the cost of commuting from home to work is not deductible as a business expense.
- ANSWER The cost of commuting is almost entirely dictated by the location of an individual's
residence. This is a personal (rather than business decision), and Congress likely did not want
to be seen as subsidizing individuals who wished to live a substantial distance from their
business location.
When is the cost of education deductible as an employee business expense? - ANSWER The
cost of education is deductible as an employee business expense if the education maintains or
improves the employee's skill in the business, but not if the education is required to qualify a
taxpayer for a new business or profession. For example, an IRS agent could not deduct the cost
of a legal education even though the education would maintain or improve his skill as a tax
auditor. This is because a law degree would also qualify the agent for a new profession (lawyer).
How might the reimbursement of a portion of an employee expense influence the deductibility
of the expense for the employee? - ANSWER Employee expenses are deducted as
miscellaneous itemized deductions subject to the 2% of AGI floor limit. A reimbursement of a
portion of an employee business expense would normally be included in the employee's gross
income and would have no effect on the deductibility of the expense. An important exception
to this rule is for employee expenses reimbursed under an "accountable" plan. Among other
things, an accountable plan requires that employees provide substantiation for
reimbursement and that employers only reimburse legitimate deductible expenses.
Reimbursements from an accountable plan are not required to be included in income, but the
reimbursed expenses are not deductible, either. In essence, the reimbursements and expenses
offset each other, and both are ignored for tax purposes. If the expense exceeds the
reimbursement, the excess (unreimbursed) portion of each expense can be deducted as a
miscellaneous itemized deduction subject to the 2% of AGI floor limit.
Explain why an employee should be concerned about whether his employer reimburses
business expenses using an "accountable" plan? - ANSWER The employee should be concerned
because absent an accountable plan, reimbursements are reported as income to the employee
and the expense is reported as a miscellaneous itemized deduction subject to the 2% AGI floor.
Thus, the reimbursements would be treated as "wages" for purposes of withholding and
employment taxes, and the deduction would be unlikely to generate any reduction in taxable
income (e.g., because of the 2% AGI floor). On the other hand, if the plan qualifies as an
accountable plan, reimbursements from the plan are not required to be included in income,
but the reimbursed expenses are not deductible, either. If, however, the expense exceeds the
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
basis of the property. - ANSWER Taxpayers deduct the fair market value of property (noncash)
donations when they donate:
(1) a capital asset that has appreciated in value (the value is greater than the basis of the
property) and the taxpayer has owned the asset for more than a year before donating it
(but see exceptions below), or
(2) appreciated business assets (value greater than basis) the taxpayer owned for more than a
year before donating but only to the extent that the gain on the asset would not be treated
as ordinary income if it had been sold.
However, the deduction for an appreciated capital asset that is tangible, personal property
is limited to the adjusted basis of the property if the charity uses the property for a purpose
unrelated to its charitable purpose.
Taxpayers donating ordinary income property (or capital loss property) deduct the lesser of (1)
the fair market value of the property and (2) the adjusted basis of the property. Thus when the
value of ordinary income property (or capital loss property) is less than the basis, taxpayers
deduct the value.
Thus, taxpayers deduct the basis of the property when they contribute:
ordinary income property that has appreciated in value.
capital gain property donated to private nonoperating foundations (other than stock).
capital gain property consisting of tangible personal property and the charity uses the property
(and the taxpayer should have reasonably expected that) for a purpose unrelated to the
reason it is a charity.
,appreciated business assets held more than a year to the extent that the gain would be
recaptured as ordinary income under the depreciation recapture rules.
Describe the type of event that qualifies as a casualty for tax purposes. - ANSWER A casualty is
defined as an unexpected, unforeseen, or unusual event such as a "fire, storm, or shipwreck"
or loss from theft.
A casualty loss from the complete destruction of a personal asset is limited to the lesser of fair
market value or the property's adjusted basis. Explain the rationale for this rule as opposed to
just allowing a deduction for the basis of the asset. - ANSWER The loss from any specific event is
limited to the lesser of the economic loss or the tax basis (cost) of the asset to prevent the
deduction of otherwise nondeductible personal losses. If the basis (cost) of the asset was
always allowed for a personal casualty loss deduction, then this would have the effect of
allowing a deduction for the decline in the value of the asset prior to the casualty (assuming
that original cost exceeds the value of the asset).
This week Jim's residence was heavily damaged by a storm system that spread destruction
throughout the region. While Jim's property insurance covers some of the damage, there is a
significant amount of uninsured loss. The governor of Jim's state has requested that the
president declare the region a federal disaster area and provide federal disaster assistance.
Explain to Jim the income tax implications of such a declaration and any associated tax
planning possibilities. - ANSWER Under IRC §165(i), individuals who incur a disaster loss are
subject to the regular casualty loss floor limits ($100/10 percent of AGI), but they may elect to
claim a disaster loss for the tax year before the loss occurred (e.g., by filing an amended return
if the original return has been filed). This deduction could accelerate the tax benefit of the loss
(and any attendant refund), but also allow the taxpayer to choose the year with the most
attractive tax outcome (in terms of AGI limits, other casualty losses (or gains), and marginal tax
rate).
Describe the types of expenses that constitute miscellaneous itemized deductions and explain
why these expenses rarely produce any tax benefits. - ANSWER Miscellaneous itemized
deductions consist of employee business expenses (not reimbursed under an accountable plan),
investment expenses (not related to rental or royalty activities), and tax preparation fees. These
deductions must be reduced by two percent of AGI before the deductions can be combined
with other itemized deductions. This floor limit makes it unlikely these itemized deductions will
generate any tax benefit.
, Explain why the cost of commuting from home to work is not deductible as a business expense.
- ANSWER The cost of commuting is almost entirely dictated by the location of an individual's
residence. This is a personal (rather than business decision), and Congress likely did not want
to be seen as subsidizing individuals who wished to live a substantial distance from their
business location.
When is the cost of education deductible as an employee business expense? - ANSWER The
cost of education is deductible as an employee business expense if the education maintains or
improves the employee's skill in the business, but not if the education is required to qualify a
taxpayer for a new business or profession. For example, an IRS agent could not deduct the cost
of a legal education even though the education would maintain or improve his skill as a tax
auditor. This is because a law degree would also qualify the agent for a new profession (lawyer).
How might the reimbursement of a portion of an employee expense influence the deductibility
of the expense for the employee? - ANSWER Employee expenses are deducted as
miscellaneous itemized deductions subject to the 2% of AGI floor limit. A reimbursement of a
portion of an employee business expense would normally be included in the employee's gross
income and would have no effect on the deductibility of the expense. An important exception
to this rule is for employee expenses reimbursed under an "accountable" plan. Among other
things, an accountable plan requires that employees provide substantiation for
reimbursement and that employers only reimburse legitimate deductible expenses.
Reimbursements from an accountable plan are not required to be included in income, but the
reimbursed expenses are not deductible, either. In essence, the reimbursements and expenses
offset each other, and both are ignored for tax purposes. If the expense exceeds the
reimbursement, the excess (unreimbursed) portion of each expense can be deducted as a
miscellaneous itemized deduction subject to the 2% of AGI floor limit.
Explain why an employee should be concerned about whether his employer reimburses
business expenses using an "accountable" plan? - ANSWER The employee should be concerned
because absent an accountable plan, reimbursements are reported as income to the employee
and the expense is reported as a miscellaneous itemized deduction subject to the 2% AGI floor.
Thus, the reimbursements would be treated as "wages" for purposes of withholding and
employment taxes, and the deduction would be unlikely to generate any reduction in taxable
income (e.g., because of the 2% AGI floor). On the other hand, if the plan qualifies as an
accountable plan, reimbursements from the plan are not required to be included in income,
but the reimbursed expenses are not deductible, either. If, however, the expense exceeds the
