Income Tax Fundamentals Exam Questions and Correct Answers (Already Passed)

Income Tax Fundamentals Exam Questions and Correct Answers (Already Passed) Internal Revenue Code - aka Federal Tax Law - Answers Primary source of all tax law Treasury Regulations - Answers Source for all tax law Revenue Rulings/Revenue Procedures - Answers Administrative interpretation, may be cited as a precedent Congressional Committee Reports - Answers May not be cited as a precedent Private Letter Rulings - Answers Apply to a specific taxpayer in a particular situation Judicial Sources - Answers Court decisions interpret law and/or facts Step Transaction - Answers Ignore the individual transactions and tax the ultimate transaction Sham Transaction - Answers Lacks a business purpose and economic substance will be ignored for tax purposes (ex: selling xyz to abc, when both xyz and abc are owned by the same person) Substance over Form - Answers The substance of a transaction and not merely its form governs its tax consequences (Ex, president of xyz company takes a loan for himself, with no written agreement. he never intends to pay back the loan or to take a salary. The loan "salary" is taxed to the president Assignment of Income - Answers Income is taxed to "the tree that grows the fruit", even if assigned to someone else (ex: owner of xyz directs that all income be paid to his son, but owner reports no income. The income is taxed to the owner) Hobby Loss - Answers Income is reportable. Any activity generating income for 3 of 5 years is a business not a hobby. For horses, profit is needed only 2 of 7 years Who MUST File??? - Answers Individuals (US Citizens) Dependents Children under 24 (kiddie tax rules) Self Employed Aliens Self Employment Earnings - Answers Must file if in excess of $400 Amended Returns - Answers 1040X Estates and Trusts - Answers 1041 Who can represent a taxpayer before the IRS - Answers attorney CPA enrolled agent enrolled actuary and any other person permitted to represent a client before the IRS CFP Certificant not classified as an audit rep Tax Penalty - Frivolous Return - Answers $5,000 Omits info necessary to determine taxpayer's tax liabiliity Negligence - Answers An accuracy penalty. Due to negligence or disregard of rules. Penalty is 20% of underpayment attributed to negligence Fraud - Answers The intent to cheat the government by deliberately understating tax liability. Penalty is 75% of the tax underpayment that is attributable to fraud Failure to pay - Answers .5% per month, max of 25% Failure to file - Answers 5 % of the tax due each month with a max of 25%` To avoid tax penalties, pay: - Answers 90% of the CURRENT year's tax liability OR 100% of the prior year's liability OR 110% if the prior year's AGI exceeded $150,000 Head of Household - Answers Maintains principal residence Provide more than 50% of child's support Qualifying Widow(er) - Answers Must maintain home for a dependent child Must not remarry Can file as MFJ in the year of death and two years after Flow Chart for Taxes - Answers Gross Income (less adjustments/above the line) AGI (less deductions/below the line) Taxable Income (time appropriate tax rates) Taxable Calculation (less credits plus other taxes) Tax Liability (less quarterly payment and withholding) New Tax Due/Refund Income Items Included on 1040 - Answers Ordinary Dividends (Sch 6) Taxable Interest (Sch 6) Business income/losses (Sch C) Capital gains/losses (Sch D) Real Estate (Sch E) Punitive Damages Wages/Salaries/Tips IRA Distributions Pensions/Annuities Items EXCLUDED from Gross Income - Answers Gifts Inheritances Child Support Municipal Bond Income Workers Comp Payments Compensatory Damages Student Loans - Answers up to $2,500 of student loan interest can be deducted from income (above the line) Tax Treatment of Scholarships - Answers Tuition and Books are EXCLUDED from income Room and Board IS Taxable Income If Scholarship is paid to the child, it's their income. EX: Full scholarship for $20,000. $12,000 for tuition, $1,000 for books, remainder for room and board. Taxable income to child is: $7,000. Investment Interest Deduction - Answers Investment interest is interest paid on indebtedness for property help for investment (ex: margin account interest) Max deduction allowed for investment is limited to Net Investment Income. Re: Margin Interest Deduction - Answers Can ONLY deduct up to net investment income amount Investment Income is: - Answers Interest Dividends Royalties Short Term Gains Buying Tax-Exempt Bonds on Margin - Answers NO DEDUCTION IS PERMITTED FOR INTEREST PAID ON DEBT INCURRED TO PURCHASE TAX-EXEMPT BONDS Ordinary Dividends vs Qualified Dividends - Answers Qualified Dividends are ordinary dividends taxed at the lower long-term capital gains rate, rather than ordinary A Note on Casualty and Theft Losses (schedule A) - Answers Can only deduct the unreimbused loss (so whatever you lost, less your insurance compensation)