Chapter 5
What is James’ income or loss from the rental property?
a.
$- 0 –
b.
$1,000 loss
c.
$1,250 loss
d.
$1,000 income
e.
$1,200 income
c
89. Girardo owns a condominium in Key West. During the year, Girardo uses the condo a total of 22 days. The condo is
also rented to vacationers for a total of 78 days and generates rental income of $24,000. Girardo incurs the following
expenses before allocation:
Mortgage interest
Property taxes
Utilities
Insurance
Depreciation
The amount of depreciation that Girardo may deduct with respect to the rental property is
a.
$7,300
b.
$9,960
c.
$14,040
d.
$17,160
e.
$22,000
90. Karen owns a vacation home in Door County, Wisconsin. During the year, she rents it out for two weeks and uses it
personally for three weeks. Her expenses directly related to renting out the property were utilities $300, and maid service
$150. The portion of taxes allocable to the rental activity is $600 and revenue from the rental is $1,000. Karen will
a.
report no income and deduct $50.
b.
report no income and deduct no rental expenses related to the vacation home.
c.
report income of $1,000 and deduct $450 of expenses for adjusted gross income.
d.
report income of $1,000 and $150 of expenses from adjusted gross income.
e.
report income of $1,000 and deduct $1,000 of expenses for adjusted gross income.
91. Landis is a single taxpayer with an adjusted gross income of $280,000. In addition to his personal residence, Landis
owns a vacation home in Beaver Creek, Colorado. He uses the vacation home for 21 days during the current year and
rents it out to unrelated parties for 63 days. After making the appropriate allocation between rental and personal use, the
following rental loss is determined:
Rental income
$14,000
Mortgage interest and property taxes
(3,200)
Utilities, maintenance, and repairs
(6,000)
Depreciation
(8,000)
Rental loss
$(3,200)
What is the correct reporting of the rental income and expenses?
I.
Because the rental shows a loss, Landis reports no income and deducts the mortgage
interest and property taxes as an itemized deduction.
II.
Landis must report the $14,000 in rental income but he can deduct only $14,000 of the
Chapter 5
expenses.
III.
Landis’s depreciation deduction is limited to $4,800.
IV.
Because the vacation home is a qualified second residence, Landis can deduct the $1,600
loss for adjusted gross income.
a.
Only statement II is correct.
b.
Only statement IV is correct.
c.
Only statement I is correct.
d.
Statements II and III are correct.
e.
Statements II and IV are correct.
92. Elise is a self-employed business consultant who operates her business out of an office in her home. The home office
passes the qualifying tests for deducting office in the home expenses. For the current tax year, Elise earns $90,000 from
her business activities. She incurs $82,000 in supplies, travel expenses, wage expense, etc. Elise‘s mortgage interest and
real estate taxes allocable to the home office space were determined to be $9,000. Also, other expenses including
insurance, repairs and maintenance, utilities, and depreciation allocable to the home office space total $11,000. How much
of the other expenses (insurance, repairs, etc.) can Elise deduct?
a.
$- 0 –
b.
$2,000
c.
$8,000
d.
$9,000
e.
$11,000
a
93. Frank is a self-employed architect who maintains a qualifying office in his home. Frank has $80,000 gross income
from his practice and incurs $72,000 in salaries, supplies, computer services, etc. Frank’s mortgage interest and real estate
taxes allocable to the office total $3,000. Other expenses total $9,000 and consist of depreciation, utilities, insurance, and
maintenance. Frank’s total office in home deductions are
a.
$3,000
b.
$5,000
c.
$8,000
d.
$9,000
e.
$12,000
c
94. Jim operates a business out of his home. One room in his home is used for business and qualifies as a home office.
Which of the following allocable expenditures can Jim use in computing his home office expense deduction?
I.
Jim pays his housekeeper $25 a week to sweep, dust and straighten-up his office.
II.
Jim’s fire and casualty insurance premiums on his home are $800.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
95. In which of the following independent situations is the taxpayer entitled to deduct expenses related to the home office?
Chapter 5
I.
A real estate agent employed by a local real estate agency owns several rental properties.
She regularly and exclusively uses a second bedroom in her home solely as an office for
bookkeeping and other activities related to management of the rental properties. She has
no other place to perform these functions.
II.
An attorney employed by a large law firm frequently brings work home from the office.
She uses a study in her home for doing this work as well as managing her investment
portfolio.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
a
96. Safina is a high school teacher. She has set aside one room in her home exclusively as a home office where she grades
papers, prepares for class, etc. No revenues are generated from her activities. Depreciation and maintenance are $800 on
the home office space. How much of the expenses are deductible by Safina?
a.
$- 0 –
b.
$200
c.
$400
d.
$500
e.
$800
a
97. Generally income tax accounting methods are designed to result in
I.
a proper application of the wherewithal-to-pay concept.
II.
a proper matching of expenses to the revenues being generated.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
a
98. Generally income tax accounting methods are designed to result in
I.
a tax based on the amount of cash available in the current period to pay taxes.
II.
a denial of a current deduction for costs that will not have to be paid in the near future.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
99. Generally income tax accounting methods are designed to result in
I.
a proper matching of expenses to the revenues being generated.
II.
a denial of a current deduction for costs that will not have to be paid in the near future.
a.
Only statement I is correct.
Chapter 5
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
100. William, a single taxpayer, has $3,500 state income tax withheld from his paychecks in 2014. When he filed his 2014
state income tax return on April 15, 2015, he calculated and received a $600 refund. The $600 refund was received on
May 27, 2015. What are the federal tax effects of the state income tax events of 2014 and 2015?
I.
If his itemized deductions total $6,000 in 2014, William includes $300 in gross income for
2015,
II.
If he did not itemize his deductions in 2014, none of the refund is included in 2015 gross
income.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
101. Jenny, an individual cash basis taxpayer, has $6,000 of state income taxes withheld from her salary during 2015.
When she filed her 2014 state income tax return during April 2015, she paid an additional $500 in state income taxes.
When she filed her 2015 state income tax return in April 2016, she received a $200 refund. What is her state income tax
deduction for 2015 for federal income tax purposes?
a.
$500
b.
$5,800
c.
$6,000
d.
$6,300
e.
$6,500
e
102. Harold, a cash basis taxpayer, borrows $65,000 for his business on a 2-year note from First City Bank on December
1, 2015. To close on the loan agreement, Harold is required to prepay interest of $4,800 on December 1. How much
interest can Harold deduct in 2015?
a.
$- 0 –
b.
$200
c.
$400
d.
$2,400
e.
$4,800
103. Amy borrowed $25,000 for her business from a local bank two years ago. To increase her deductions for 2015, she
pays December interest of $400 and prepays January and February interest totaling $800 on December 30, 2015. The
maturity date of the note is November 30, 2016. How much of the interest that she paid in December is deductible in
2015?
I.
If she is a cash-basis taxpayer, Amy’s interest deduction is $1,200.
II.
If she is an accrual-basis taxpayer, Amy’s interest deduction is $400.
a.
Only statement I is correct.
Chapter 5
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
104. Janine, a cash-basis taxpayer, borrowed $15,000 for her business from a local bank three years ago. To increase her
deductions for 2015, she pays December interest of $150 and prepays January and February interest totaling $300. The
maturity date of the note is November 30, 2016. How much of the interest is deductible in 2015?
a.
$-0-
b.
$150
c.
$300
d.
$450
105. Electronic City sells various electronic products. With each of its products, Electronic City offers customers the
option of purchasing a repair contract. Under the contracts, Electronic City will make repairs anytime during the term of
the contract. Electronic City estimates that repair costs related to this year’s sales will be $39,000. During the current year,
Electronic City incurs repair costs of $37,000 related to prior year’s contracts and $4,000 on contracts sold this year.
I.
If Electronic City accounts for the contracts using the accrual method of accounting, its
repair cost deduction is $39,000.
II.
If Electronic City accounts for the contracts using the cash method of accounting, its repair
cost deduction is $41,000.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
106. Christy purchases $1,000-worth of supplies from a local vendor. The supplies are delivered on March 29, 2015. The
supplies are fully used up by year end. Because of unusual circumstances, a bill for the supplies arrives from the vendor
on January 10, 2016, and is promptly paid. When can Christy deduct the expenses?
I.
In 2015, if she is an accrual basis taxpayer.
II.
In 2016, if she is a cash basis taxpayer.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
107. Sergio purchases $3,000-worth of supplies from a local vendor. The supplies are delivered on April 1, 2015. The
supplies are fully used up on December 31, 2015. Because of unusual circumstances, a bill for the supplies arrives from
the vendor on February 1, 2016, and is promptly paid. When can Sergio deduct the expenses?
I.
In 2015, if he is an accrual basis taxpayer.
II.
In 2015, if he is a cash basis taxpayer.
a.
Only statement I is correct.
b.
Only statement II is correct.
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c.
Both statements are correct.
d.
Neither statement is correct.
108. In which of the following circumstances would a cash basis taxpayer be required to account for an item of income or
deduction under the accrual method of accounting?
a.
Alice receives advance payment for services that she will perform and complete by the end of the following
tax year.
b.
Ben paid his business property taxes at year-end even though they were not due until the end of January.
c.
Cheryl received six months of pre-paid rent on her rental property just before the end of the year.
d.
Donald prepaid a one-year service contract on his copy machine just before year-end.
e.
A cash basis taxpayer will not be required to use the accrual basis method of accounting in any of the above
circumstances.
109. The all-events test requires that
I.
All events have occurred that determine a liability exists
II
The due date for payment of the liability has been established
III.
The amount of a liability is determined with reasonable accuracy.
a.
Only statement I is correct.
b.
Statement I and II are correct.
c.
Statement I and III are correct
d.
Statements I, II, and III are correct.
e.
Only statement III is correct
110. If someone provides a taxpayer with either property or services, economic performance occurs when
a.
The taxpayer actually uses the property.
b.
The property or services are actually provided.
c.
The liability to pay for the property or services exists.
d.
The taxpayer pays the other person for the property or services.
111. Twin City Manufacturing Corporation is an accrual basis taxpayer. Twin City Manufacturing provides medical
insurance for its employees through a self-insured reimbursement plan. Twin City Manufacturing pays $100 per month
per employee into the plan fund. The fund is then used to reimburse employees’ medical expenses. During the current
year, Twin City Manufacturing Corp. pays $12,000 into the fund and pays medical reimbursement claims of $10,600.
I.
If Twin City Manufacturing is an accrual basis taxpayer it can deduct $12,000.
II.
If Twin City Manufacturing is a cash basis taxpayer it can deduct $10,600.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
112. An accrual basis taxpayer may deduct expenses in the year in which certain tests are met. These tests include
Chapter 5
I.
when services or property are provided to the taxpayer or when the taxpayer uses the
property.
II.
when the “all-events test” is met.
III.
when “economic performance” has occurred.
IV.
when all events have occurred to determine that a liability exists and the amount of the
liability can be determined with reasonable accuracy.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Statements I and IV are correct.
d.
Statements II and III are correct.
e.
Statements I, II, III, and IV are correct.
e
113. If a taxpayer owes interest, economic performance occurs
I.
with the passage of time.
II.
when the all-events test is met.
III.
when payments are made by the taxpayer.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Only statement III is correct.
d.
Statements II and III are correct.
e.
Statements I, II, and III are correct.
a
114. Angela is an accrual basis taxpayer. On September 1 of the current year, she prepays the annual premium of $4,800
for a one-year fire insurance policy on the contents of her business warehouse. The expense is not material for either
financial or tax purposes. The prepayment is necessary to activate the insurance coverage and maintain annual renewals.
How much may Angela deduct in the current year?
a.
$- 0 –
b.
$ 400
c.
$1,600
d.
$2,400
e.
$4,800
e
115. An exception to the economic performance test allows the deduction of year-end accruals if
I.
The liability exists and the amount of the liability can be reasonably estimated.
II.
Economic performance occurs within the shorter of 8 1/2 months after the close of the tax
year or a reasonable time after the close of the tax year
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
c
116. An exception to the economic performance test allows the deduction of year-end accruals if
I.
Either the expense is not material for both tax and financial purposes or the accrual results
in a better matching of revenue and expenses.
II.
The taxpayer consistently treats the item as incurred in the year the all events test is met.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
117. Due to a shortage of cash, East Coast Entertainment Company, an accrual basis taxpayer, could not pay its November
2015 utility bill on time. In February of 2016, East Coast Entertainment pays the utility bill.
I.
East Coast can deduct the expense on either its 2015 or 2016 tax return.
II.
East Coast cannot deduct the utility expense in 2015 because it is paid in 2016.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
118. Indicate which of the following statements is/are correct:
I.
An accrual basis taxpayer who gives a creditor his note payable in payment of a claim may
deduct the related expense when the note is given.
II.
When a cash basis taxpayer uses a credit card to pay for an expense it can deduct the
expense when the expense is charged to the credit card..
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
119. Indicate which of the following statements is/are correct:
I.
A cash basis taxpayer may deduct prepaid rent if it will be used-up within one year of
prepayment and the payment is required to be made.
II.
An accrual basis taxpayer must satisfy an all-events test and an economic performance test
to claim a deduction.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
120. Richard, a cash basis taxpayer, is an 80% owner and president of WLFI TV. WLFI TV is an S corporation and uses
the accrual method of accounting. On December 1, 2015, WLFI TV accrues a bonus of $50,000 to Richard. The bonus is
payable on January 31, 2016. In what year does Richard report the income and WLFI TV take the deduction?
Chapter 5
Richard WLFI TV
a.
2016 2015
b.
2016 2016
c.
2015 2015
d.
2015 2016
121. Harold is a 90% owner of National Homes Construction, an accrual basis S corporation. On December 30, 2014,
National Homes accrues a $100,000 bonus to Harold, payable on February 15, 2015.
I.
If Harold is an accrual basis taxpayer, National Homes deducts the bonus in 2014 and
Harold reports the income in 2015.
II.
If Harold is a cash basis taxpayer, National Homes deducts the bonus in 2014 and Harold
reports the income in 2015.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
122. For its financial accounting records Addison Company uses the allowance method to account for bad debts and
estimates the balance in the “Allowance for Bad Debts” account using the aging method. For tax purposes, the allowance
method cannot be used. The rationale for not allowing this method is
a.
The arm’s length transaction concept has not been met.
b.
The all-events test has not been met.
c.
The Business Purpose Concept has not been met.
d.
Lack of constructive payment.
123. Income tax accounting methods and financial accounting methods differ in many ways. Which of the following tax
law provisions are likely to create permanent differences between taxable income and financial (or book) income of a
single entity?
I.
Treatment of payment of penalties and fines.
II.
Disallowance of 50% of the cost of business meals and entertainment.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
124. Income tax accounting methods and financial accounting methods differ in many ways. Which of the following tax
law provisions are likely to create permanent differences between taxable income and financial (or book) income of an
entity?
I.
The cost of certain property is allowed to be deducted in the year of acquisition rather than
through regular depreciation methods.
II.
Tax depreciation is computed over a statutory life rather than the asset’s useful life.
a.
Only statement I is correct.
Chapter 5
b.
Only statement II is correct.
c.
Both statements are correct.
d.
Neither statement is correct.
125. Dustin, Dan, and Dennis operate Heritage Hills dry cleaners as an S corporation. Dustin owns 50% of the business,
Dan 30%, and Dennis 20%. For the current year, Heritage Hills reports the following:
Sales revenues
$400,000
Trade and business expenses
(185,000)
Charitable contributions
(5,000)
Short-term capital losses
(4,000)
Long-term capital gains
12,000
Taxable income
$218,000
How must Heritage Hills report its results to each of the owners?
126. List the criteria necessary for an expenditure to be deductible as a trade or business expense or an expense for the
production of income.
– not related to tax-exempt income
– not another person’s expense
127. Discuss whether the following persons are currently engaged in a trade or business:
a.
Darlene has expenses related to managing her portfolio of securities. The trading of the
securities generates most of her annual income. She generally does not hold securities long-
term. She buys and sells continuously. She has no other job.
Chapter 5
b.
Mark incurs expenses related to investing in stocks and bonds. Mark is a Sociology
professor at Indiana University but spends 10–15 hours per week on his investments.
Approximately 70% of Mark’s annual income come from his investments as dividends and
interest.
c.
Paul leases real estate to Floyd’s Barber Shop for a parking lot. The only expense he incurs is
legal expense regarding the lease, which he renegotiates annually.
d.
Mandy owns several rental apartments. She arranges for repairs and maintenance, pays for
the expenses related to the properties, and handles all leasing activities.
b.
No. Although almost 70% of his income comes from the investments, this is not Mark’s
No. Leasing the property is not a trade or business for Paul. Paul is not actively involved
manage the enterprise.
128. Discuss whether the following persons are currently engaged in a trade or business:
a.
Katerina owns 35 home sites in and around Orlando. She bought these vacant lots several
years ago in hopes to developing them into a subdivision. She begins to develop the lots in
the current year.
b.
John spends 2 hours a day, 5 days a week, managing his investment portfolio. He watches
the market and buys and sells securities when he thinks the market is right. His investment
strategy is to realize dividends, interest, and long-term gains from holding the investments.
c.
Bill lives in Miami and works full-time betting on dog races. Although he intends to win
large sums, he has failed to win the big one. He considers his betting activities his job and
relies on his meager winnings to support his family. He is devoted to the races and has
rarely missed a day betting in over 3 years.
b.
No. John is an investor. He realizes income from holding the securities long-term. He is not
129. Larry is a history teacher. He subscribes to several periodicals about teaching history and judging history fairs. This
year Larry spends $285 on subscriptions to various periodicals. Discuss the deductibility of the expenditures for tax
purposes.
130. Discuss whether the following expenditures meet the ordinary, necessary, and reasonable requirements for
deductibility.
a.
Mortimer owns a shoe store. Every August Mortimer has a “Back-to-School” sale. To
promote that event Mortimer spends $2,000 on newspaper and radio advertising.
Generally, this event generates about $85,000 in sales. These sales revenues are about
twice the level of sales in other months.
b.
Wilma bought a small manufacturing business that had been declared bankrupt. To retain
the current sales force, she pays some of the obligations owed to these people by the
former owners. Wilma has no legal obligation to pay these debts.
c.
Ned owns a large sporting goods store. Nick’s 17-year-old son, Tony, works in the store
when time permits. Nick pays Tony $10 per hour because he has worked in the store
several years. Other high school age individuals also work at the store and perform
functions requiring less experience than Tony. They are paid $8 per hour.
d.
Art is a self-employed CPA. Last month he attended an AICPA Continuing Education
course that cost him $750. In addition to the course registration fee, Art incurred $800 in
travel expenses to attend the course.
e.
Elvira is a stockholder in over 100 different corporations. However, she does not own
more than 10 shares of stock in any one company. She enjoys attending annual
stockholder meetings and often gives her “two cents worth” about issues affecting the
companies’ operations. In the past year Elvira spent $7,540 to attend the stockholder
meetings to help protect her investments.
the amounts could be deemed normal and not excessive. However, the payments are not
capital expenditures to build a positive reputation.
time Tony works. The $8 per hour paid to the other students is not only reasonable, but it is
d.
All of the costs of attending the course are ordinary, necessary, and reasonable. The purpose
education expenses.
e.
The $7,540 expenditure to attend the meetings is not considered ordinary because a prudent
businessperson in the same situation would not make such a large expenditure on small
131. Using the tests for deductibility discussed in Chapter 5, explain why the following expenses are not deductible.
deductions occurs in Chapter 8.
Chapter 5
a.
Mel is a sprint car racer. He does repair and maintenance on his cars in the garage at his
home. After repairing the cars, he tests them on city streets. He received 15 citations
(totaling $2,900) for speeding, running stop signs, and reckless driving.
b.
Albert, a carpenter, pays his 10-year-old son $150 a week to empty waste cans in his work
shop. Albert’s son works each evening and two hours on Saturday morning.
c.
Sharon contributes $25 to a local organization that is campaigning against a foreign trade
bill. The legislation would damage Sharon‘s business.
d.
Marline borrows $5,000 and pays $500 in interest. The loan is used to purchase bonds
issued by the City of Lafayette School District.
e.
Christine is the wife of a physician, and she is an experienced horseman. She has raised
horses for ten years and occasionally shows them for prize money. She also boards horses
for monthly fees. She enjoys her horse activity but has never made a profit in any year.
Her horses are appraised at $200,000.
The citations are violations of public policy. Fines are not deductible.
b.
The pay is not reasonable. Someone, other than a related party, would not receive $150 for
c.
Lobbying and expenditures to influence public opinion about legislation are not deductible.
for deducting business expenses.
d.
The interest expense is incurred to earn tax-exempt income and is not deductible. Allowing
e.
Christine is an experienced horseman, she carries on the trade regularly, and her horses are
132. Using the general tests for deductibility, explain why the following expenses are not fully deductible.
a.
Irene spends $1,600 on a trip to Florida to investigate opening up a consulting firm. Irene
currently works for a consulting firm.
b.
Augie and his wife divorce during the current year. Augie pays $3,000 in legal fees related
to the divorce.
c.
Peter owns a hardware store. During the current year, he pays $328,000 to acquire a new
warehouse.
d.
Paul contributes $25 to a fund to be used for advertising to persuade voters to vote against a
candidate running for Congress.
a.
Because Irene is already in the consulting trade, she may be able to deduct the trip as a
business trip, and was not mainly personal pleasure.
The warehouse is a capital expenditure. Therefore, the $328,000 cost is capitalized and
133. Using the tests for deductibility discussed in Chapter 5, explain why the following expenses may not be fully
deductible in the current year
a.
Janet pays $900 in interest on debt she incurred to purchase municipal bonds. The bonds pay
$1,500 of interest in the current year.
b.
Andrew owns a retail-clothing store. Andrew has the opportunity to obtain a franchise to
operate a discount sporting goods store. He spends $5,000 investigating the possibility of
opening a sporting goods store in a neighboring town.
c.
Jane owns a fitness center. She employs the star basketball player at Local University as an
aerobics instructor. Because of his reputation, she pays him $20 an hour. Jane pays her other
aerobics instructors $10 an hour.
d.
Alvin makes a vacation trip to Florida, and while there spends two days investigating the
feasibility of opening up a new office of his optometry practice.
Expenses paid to produce tax-exempt income are not deductible. Because the interest on the
c.
Deductible expenses must be reasonable in amount. If the extra $10 an hour that Jane pays
d.
Personal expenses are not deductible. So Alvin will be unable to deduct most of his travel
134. The Wilson Corporation incurs the following expenses. Explain whether the following expenses should be
capitalized or deducted in the current period.
a.
Paid $2,500 to blacktop a gravel parking lot.
b.
Paid $1,900 for new tires on the truck.
c.
Paid $3,000 for a new fire and security alarm system for the factory.
d.
Paid $6,250 to paint the interior and exterior of the office and factory building that it just
acquired.
e.
Paid $1,200 for a new compressor for the factory’s central air conditioning system.
operating condition. The repairs and maintenance listed above include (b) new tires for the truck; and (e)
deducted over the tax life of the warehouse using the appropriate depreciation method
d.
Expenditures that frustrate public policy are disallowed. Political contributions and
135. Using the tests for deductibility discussed in Chapter 5, explain why the following expenses may not be fully
deductible in the current year.
a.
Antonio is the owner of a restaurant. His business has been growing, and Antonio
determines that he needed to add more seating capacity. He builds a patio garden section
onto the back of the restaurant at a cost of $70,000.
b.
Tina owns a construction company. Because she is behind schedule on a project, she pays
a city building inspector $500 to get him to come out and do his inspection a week before
he had scheduled the inspection.
c.
Claude is a graduate of State University and an avid supporter of the school’s athletic
program. During the summer he employed State’s star running back in his pool cleaning
business. He paid the football player $15 an hour, although other employees doing similar
work are only paid $10 per hour.
d.
Melody owns a chain of coffeehouses. When she opened a coffeehouse in a new city this
year, she spent $20,000 advertising the new store. Even though this is much more than she
typically spends on advertising, she felt that it was reasonable because the new
coffeehouse has the potential to be a very profitable venture for many years.
Payments that frustrate public policy are not deductible. The payment to the building
the job, the $5 per hour payment would not be deductible. However, Claude can deduct
larger expenditures upon the opening of a new store). Although the amount is large, it
136. Explain the rationale for disallowing the deduction for interest expense attributable to money borrowed to acquire
tax-exempt municipal bonds.
not exist. For example, a taxpayer in the 35% tax bracket could borrow funds at 7%, invest the money in
137. Cornelius owns a condominium in Orlando. During the year, Cornelius uses the condo a total of 25 days. The condo
is also rented to vacationers for a total of 75 days and generates rental income of $9,000. Cornelius incurs the following
expenses:
Mortgage interest
$4,000
Property taxes
1,800
Utilities
2,000
Insurance
1,200
Depreciation
10,000
Determine Cornelius’s deduction related to the condominium. Indicate the amount of each expense that can be deducted
and how it would be deducted.
Rental income
Allocated expenses:
Interest & taxes $5,800 ⋅ 75/100
Balance of income
Utilities & Insurance $3,200 ⋅ 75/100
Balance of income
138. Wilson owns a condominium in Gatlinburg, Tennessee. During the current year, she incurs the following expenses
before allocation related to the property:
Mortgage interest
$10,000
Property taxes
4,000
Utilities
1,000
Maintenance fees
1,300
Repairs
800
Depreciation
6,000
a.
For each of the following scenarios indicate whether Wilson would treat the condominium
for income tax purposes as personal use property, a rental or a vacation home.
Case
Rental
Income
Rental
Days
Personal
Use Days
Personal, rental,
or vacation
A
$10,000
300
0
B
7,000
60
10
C
15,000
60
20
D
2,000
10
40
Chapter 5
E
11,000
280
20
b.
Consider Case C. Determine Wilson’s deductions related to the condominium. Indicate the
amount of each expense that can be deducted and how it would be deducted.
a.
Personal, rental, or
b.
$2,325 ($4,500 – $2,175) of depreciation not deducted in the current year can be carried forward to offset
Match each statement with the correct term below.
a.
Specifically disallowed.
b.
Appropriate and helpful.
c.
Considered a trade or business.
d.
Not considered a trade or business.
e.
Problems with this generally arise with related parties.
Chapter 5
f.
This is met when services or property are provided to the taxpayer.
g.
Normal, common, and accepted but not necessarily regularly recurring.
h.
This is met when the existence and the amount of a liability have been established.
139. Active Trader
140. Active Investor
141. All-events Test
142. Economic Performance
143. Necessary Expense
144. Ordinary Expense
145. Personal Expense
146. Reasonable Expense
Match the proper deduction method with the correct expenditures.
a.
Capitalized and amortized over a number of accounting periods
b.
Expensed in the period incurred
c.
Not deductible
d.
Can be capitalized and amortized or deductible depending on the amount of the expenditure
147. Betterment
148. Covenant not to compete for 4 years
149. Fire and casualty insurance premium on business warehouse
150. Hobby loss
151. Illegal gambling operation expenses
152. Investment expenditures related to earning interest from municipal bonds
153. Federal lobbying expenditures
154. Organization costs
155. Political contributions
156. Premiums the insured taxpayer pays for life insurance
157. Repair-and-maintenance expenditures
158. Start-up costs over $5,000.
Match each statement with the correct term below.
a.
Automobile used 75% for business.
b.
Investment expenses on municipal bonds.
c.
Cost of investigating a new trade or business that the taxpayer enters.
d.
Can be separated into two classifications.
e.
Safety-deposit box for taxable investments.
f.
Expenditure to influence legislation.
g.
Cost of a new roof for office building.
h.
Relates to an income producing activity mainly carried on for recreation or personal enjoyment.
i.
Deductibility depends on income and amount of personal and rental use.
j.
Deductibility depends on whether the area is used exclusively for trade or business activities.
159. Amortizable or deductible expense
160. Capital expenditure
161. Hobby expense
162. Home office deduction
163. Lobbying expense
164. Mixed-use asset
165. Non-deductible expense
166. Production-of-income expense
167. Profit motivated business expenses
168. Vacation home expense