TAX 4001 Exam 2 | Questions & Answers (100 %Score) Latest Updated 2024/2025
Comprehensive Questions A+ Graded Answers | With Expert Solutions
It has been suggested that tax policy favors deductions for AGI compared to itemized deductions.
Describe two ways in which deductions for AGI are treated more favorably than itemized deductions. -
Itemized deductions must exceed the standard deduction before taxpayers receive any tax benefit from
the deductions (this is equivalent to an overall floor limit). In contrast, business deductions that are
deductible for AGI (above the line) reduce taxable income without being subject to an overall floor limit.
Also, itemized deductions are subject to many mechanical limitations including ceilings, floors, and
phase-outs whereas business deductions are generally not subject to these limits (there are limits on
certain specific deductions, but this will be described in greater detail in chapter 9).
How is a business activity distinguished from an investment activity? Why is this distinction important
for the purpose of calculating federal income taxes? - Both business and investment activities are
motivated primarily by profit intent, but they can be distinguished by the level of profit-seeking activity.
A business activity is commonly described as a sustained, continuous, high level of profit-seeking
activity, whereas investment activities don't require a high level of involvement. The distinction can be
important for the location of deductions, because business deductions are claimed above the line (for
AGI on Schedule C) while investment deductions are generally itemized or from AGI deductions (with
the exception of rent and royalty expenses which are deductible for AGI on Schedule E).
Describe how a business element is reflected in the requirements to deduct moving expenses and how
Congress limited this deduction to substantial moves. - A business element is reflected in both the
distance test and time test associated with the move. To satisfy the distance test, the distance from the
taxpayer's old residence to the new place of work (business element) must be at least 50 miles more
than the distance from the old residence to the old place of work (business element). The time test for a
moving expense deduction requires the taxpayer to be employed full time 39 of the first 52 weeks (or
self-employed for 78 of the first 104 weeks) after the move (obviously reflecting a business element).
Explain why Congress allows self-employed taxpayers to deduct the cost of health insurance above the
line (for AGI) when employees can only itemize this cost as a medical expense. Would a self-employed
taxpayer ever prefer to claim health insurance premiums as an itemized deductions rather than a
deduction for AGI? Explain. - This deduction provides a measure of equity between employees and the
self-employed. The cost of health insurance is essentially a personal expense. However, employees
typically aren't required to pay insurance premiums because their employers pay the premiums for
them as a form of compensation. The employer is allowed to deduct the premium as a compensation
expense, and the employee is allowed to exclude from taxable income the value of the premiums paid
on his behalf. Thus, from the employee's perspective, this arrangement has the same effect as if (1) the
employer pays the employee cash compensation in the amount of the premium and (2) the employee
pays the premium and deducts the expense for AGI (completely offsetting the compensation income). In
,contrast to employees, self-employed taxpayers pay their own health insurance costs, because they
don't have an employer to pay these costs for them. Absent a rule to the contrary, self-employed
taxpayers would deduct their medical expenses as itemized deductions subject to strict limitations,
because the cost of the health insurance is a personal expense rather than a business expense. To treat
employees and self-employed taxpayers similarly, Congress allows self-employed taxpayers to deduct
personal health insurance premiums as for AGI rather than itemized deductions. Thus, self-employed
taxpayers are able to (1) receive business income and (2) use the business income to pay their health
insurance premiums and deduct the premiums as a for AGI deduction (completely offsetting the
business income they used to pay the premium). Given the preferential treatment of for AGI deductions
relative to itemized deductions, a self-employed taxpayer should never prefer to claim health insurance
premiums as an itemized deduction rather than a deduction for AGI.
Explain why Congress allows self-employed taxpayers to deduct the employer portion of their self-
employment tax. - 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.
- §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. - 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. - 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. - 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? - 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? - 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? - 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. - 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
