KEIR S INCOME TAX PLANNING

KEIR S INCOME TAX PLANNING Published by: KEIR EDUCATIONAL RESOURCES 4785 Emerald Way Middletown, OH 45044 1-800-795-5347 1-800-859-5347 FAX E-mail customerservice@keirsuccess.com www.keirsuccess.com

INTRODUCTION Keir Companion Series Income Tax Planning combines two of Keir s popular books that were originally offered separately the Summary Review and the Multiple Choice Question Workbook. This book will simplify the study process because each chapter now includes a detailed summary review of the important principles and concepts followed by numerous multiple choice questions with detailed answers. This book provides a student with the essential elements needed for passing a college examination. The way a student uses this book will depend on the student s prior level of knowledge. Many will speedread this book and then score adequately when answering the review multiple choice questions. Others will read more slowly, and for some people a second or third reading may be necessary. The essential substance is all here. The student can set his or her own pace for the journey. The use of chapter paragraph numbers is designed to assist the student in working through the practice questions at the end of each chapter. Paragraph numbers at the end of each question refer the student to the place in the chapter where the answer to the multiple choice question can be found. These paragraph references may be helpful when the student is not sure of the answer or would like additional detail. However, in most cases, the Answers and Rationales provided give adequate information concerning each multiple choice question, so referring to the chapter may be necessary only for more indepth treatment of the subject matter. If a student does not score 75 percent or higher for a particular assignment, the student probably has not mastered the material in accordance with examination standards. A grade of less than 75 percent would suggest the student should, at a minimum, review the detailed answers for every question missed and the related paragraphs in the chapter. Students who need to review the concepts in more detail may want to refer to the primary textbook for the course. In the preparation of these multiple choice questions, Keir made no attempt to anticipate specific cases or questions that are likely to appear on the final examination for a college course. No one can outguess the class professor. What we have attempted to do is select questions that test a student s understanding of important concepts presented in the study materials. Students will find these questions cover the material in an exceedingly thorough manner. Certified Financial Planner Board of Standards, Inc. owns the marks CFP, CERTIFIED FINANCIAL PLANNER, and CFP (with flame logo), which it awards to individuals who successfully complete initial and ongoing certification requirements. Keir Educational Resources is a Review Course provider for the CFP Certification Examination administered by Certified Financial Planner Board of Standards, Inc. CFP Board does not endorse any review course nor receive any financial remuneration from Review Course providers. 2017 Keir Educational Resources ii www.keirsuccess.com

TABLE OF CONTENTS Chapter Title Page One Income Concepts Basic Terminology and Tax Calculation One: The Tax Computation 7 Two: Methods of Managing Tax Liability 22 Two Tax Accounting and Forms of Business One: Cash vs. Accrual Accounting 37 Two: Tax Accounting Methods 38 Three: Inventory Valuation 39 Four: Characteristics of Business Forms 41 Five: S Corporation Requirements 50 Six: Choosing a Business Form 51 Seven: Home Office Expense 57 Three Income Tax Aspects of Property Acquisitions and Introduction to Property Dispositions One: Types of Property 75 Two: Property-Related Expenditures 76 Three: Basis Issues 77 Four: Cost Recovery 79 Five: Sec. 179 82 Six: Property Sales 84 Seven: Sec. 1231 Rules 84 Four Income Tax Aspects of the Disposition of Property One: Like-Kind Exchanges 100 Two: Sale of a Principal Residence 103 Three: Installment Sales 104 Four: Casualty and Theft Losses 105 Five: Involuntary Conversions 106 Five Six Passive Activity Losses and Vacation Homes One: Passive Activity Losses 117 Two: Vacation Home Rules 125 Income Tax Aspects of Securities One: Life Insurance 142 Two: Annuities 144 Three: Capital Gains and Losses 146 Four: Investment Interest Expense 150 Five: Dividends and Net Present Value 151 Seven Tax Planning for the Family One: Intra-Family Transfers 170 Two: Grantor Trust Rules 177 Three: Charitable Contributions 178 Four: Alimony Considerations 183 2017 Keir Educational Resources iii 800-795-5347

TABLE OF CONTENTS, CONTINUED Chapter Title Page Eight Tax Law Research and Special Income Tax Considerations One: Overview of Individual Income Taxation 206 Two: Tax Law Research 208 Three: Additional Taxes 210 Four: Tax Traps, Penalties, and Penalty Taxes 215 Glossary 236 Index 252 Appendix I 2017 Tax Structure 31, 258 Appendix II 2016 Tax Structure 31, 258 2017 Keir Educational Resources iv www.keirsuccess.com

Section One: The Tax Computation Chapter One Income Concepts Basic Terminology and Tax Calculation 1. Personal income taxation is the primary source of income for the federal government (Social Security is next). The system employed by the government in levying the federal income tax and the effect of this tax upon the economy and our society are probably the most widely reviewed, analyzed, and criticized topics in the U.S. This has been particularly true in recent years because of the frequent changes in our income Tax Code made by Congress in the name of reform, simplification, economic stimulation, and deficit reduction. 2. While there is debate over the success of recent reform efforts, there is no question regarding whether the 1986 Tax Reform Act resulted in simplification of the Tax Code. The tax calculation procedure mandated by TRA 86 is now substantially more complicated than ever before, which was further complicated by later legislation, including the 1990, 1993, 2001, 2003, 2004, 2005, 2006, 2007, 2008, 2009, and 2010 Tax Acts, along with temporary legislation in response to the great recession. Therefore, for those of us who are providing financial planning services for the public, a basic understanding of the procedure for calculating a taxpayer s individual income tax is essential. 3. The basis for the calculation is the standard Internal Revenue Service Form 1040, along with its supporting schedules. In principle, the procedure is straightforward and consists of, first, determining the taxpayer s filing status; second, determining the number of personal exemptions to which the taxpayer is entitled; third, adding up the taxpayer s income from all sources to determine his or her gross income; fourth, making certain adjustments to gross income to determine the taxpayer s adjusted gross income; fifth, subtracting from adjusted gross income the standard deduction or the dollar amount of itemized deductions; sixth, subtracting the allowance for personal exemptions from the dollar amount determined in Step five, to give the taxpayer s taxable income; seventh, calculating the tax on the taxable income; eighth, subtracting any available tax credits from the calculated tax; and ninth, adding to this tax figure any other taxes for which the taxpayer may be liable. The end result of this nine-step procedure is the taxpayer s total tax. After the total tax is calculated, tax payments (and special credits deemed by law to be payments) are compared to the total tax amount to determine if any additional tax payment is due or if the taxpayer is entitled to a tax refund. Appendices I and II provide detailed information on tax brackets, allowable deductions, personal exemptions, etc. You do not need to memorize the numerical information contained in these appendices. 4. Taking a closer look at the nine steps, first, the procedure calls for establishing the filing status of the taxpayer whether single; married, filing a joint return; married, filing separate returns; head of household; or a qualifying widow or widower. The taxpayer s filing status is the basis for determining the amount of his or her standard deduction. It is also the basis for selecting the tax schedule to use in calculating the taxpayer s liability. The key differences for each filing status are as follows: (a) To qualify for married filing jointly, a taxpayer must be legally married on the last day of the tax year or be a widow or widower in the year of the spouse s death and for two years afterwards if he or she continues to provide a household for a dependent child and remains unmarried. For example, Helen and Grant Peck had been married for 22 years when Grant died in 2016. If Helen continues to 2017 Keir Educational Resources 5 800-795-5347

Income Tax Planning Summary Review Chapter One care for the couple s youngest daughter, who is 10, in her home after Grant s death, she can use the standard deduction and tax rates for married couples filing jointly in 2016, 2017, and 2018. When a couple files jointly, they are treated as one person, which means they are jointly and severally liable for the taxes owed. However, recent legislation has expanded the availability of innocent spouse relief for cases involving a spouse who files a return, substantially understating the tax liability of the couple, without the other spouse s knowledge. In September of 2013, the IRS issued guidance regarding the federal tax treatment of individuals of the same sex who are married under state law. If a same-sex couple is married in a state that recognizes the marriage, the couple will be treated as married under federal tax law, even if the couple subsequently moves to a state that does not recognize same-sex marriages. This recognition of same-sex marriages allows same-sex couples to file using the married filing jointly filing status, which was previously unavailable to them on their federal income tax return. (b) To file singly, a taxpayer must be unmarried, divorced, or legally separated on the last day of the tax year. When a client files singly, his or her tax rate is higher than half the amount for joint filers, starting with the 25% bracket. This results in the so-called marriage penalty, where married people who both have income pay more in taxes than if they were not married. Although the American Taxpayer Relief Act extended some of the existing marriage penalty relief from the 2003 Tax Act, differences in the upper tax brackets still make a difference. For example, two single people each with $90,000 in taxable income in 2017 will each pay $18,239 in taxes, for a total of $36,478. If the two were married and had the same income ($180,000), they would pay $37,285. The extra tax for being married is $807. (c) To file as head of household, a taxpayer must be single (unless separated from his or her spouse for the last six months of the tax year) and provide half the cost of providing a household that is the principal place of abode for a child or dependent for at least half of the year. Filing as head of household will result in a more favorable standard deduction and tax rate than if filing single. For example, George and Mary Pruitt finalized their divorce this year. Mary provides a household for the couple s two children, which costs $26,000 per year, using the $12,000 in child support from George to offset those costs. The children lived with Mary, except for July and August, which they spent with George. Mary is entitled to file as head of household because she provided more than half the cost of the household ($14,000/$26,000) and the children lived with her for more than six months. (d) To file as married filing separately, a married taxpayer must just file a separate return from his or her spouse. Usually, taxes will be higher than if filing jointly because many limitations in the tax law apply to those who file using this status. However, married filing separately avoids the joint liability. 5. The second step is determining the number of exemptions. A taxpayer is entitled to one personal exemption unless he or she is eligible to be claimed as a dependent on another taxpayer s return (e.g., on a parent s return). One exemption may be claimed for each dependent child, for each additional qualifying dependent, and for the taxpayer s spouse, if a joint return is being filed. The Working Families Tax Relief Act of 2004 created a uniform definition of dependents for multiple tax deductions and credits. Starting in 2005, all dependents must: 2017 Keir Educational Resources 6 www.keirsuccess.com

Income Tax Planning Summary Review Chapter One (1) Be a citizen of the United States, Canada, or Mexico (2) Not file a joint return with another taxpayer, unless the return was filed in order to claim a refund (refund provision added in 2009 by the Fostering Connections to Success and Increasing Adoptions Act of 2008). (3) Not claim another person as their own dependent The taxpayer s children and the spouse s children will qualify as dependents if they meet the following three additional tests: (1) The child is under the age of 19, or under the age of 24 and a full-time student for at least five months during the year, or any age and permanently and totally disabled. (2) The child lives with the taxpayer for more than half the year. (3) The child does not provide more than half of his or her own support. (4) The child must be younger than the taxpayer unless the child is permanently and totally disabled (added in 2009 by the Fostering Connections to Success and Increasing Adoptions Act of 2008). If the child can be claimed by a parent, but no parent claims the child, no other taxpayer can claim the child unless the other taxpayer s AGI exceeds the highest AGI of the child s two parents (added in 2009 by the Fostering Connections to Success and Increasing Adoptions Act of 2008). Children and other family members who fail to meet the above four tests will qualify as dependents if they meet the following two additional tests: (1) The taxpayer or the taxpayer s spouse provides more than half of their support. (2) Their income is less than the $4,050 exemption amount in 2017. tests: Other nonfamily members will qualify as dependents if they meet the following three additional (1) The nonfamily member lives with the taxpayer. (2) The taxpayer or the taxpayer s spouse provides more than half of the individual s support. (3) The dependent s income is less than the $4,050 exemption amount in 2017. Total support includes any third-party benefits (e.g., AFDC, Social Security) if the benefits are spent on the potential dependent s normal living expenses. If the support test is met, the following chart will help determine whether the person can be claimed as a dependent: 2017 Keir Educational Resources 7 800-795-5347

Income Tax Planning Summary Review Chapter One Relationship Age/Status Income (only that which is taxable) Child or stepchild of the taxpayer Child or stepchild of the taxpayer Child or stepchild of the taxpayer Child or stepchild of the taxpayer Other relative (parent, brother, sister, ancestor, nephew, niece, in-law, uncle, and aunt) of the taxpayer, whether he or she lives with taxpayer or not Other individuals who live in the taxpayer s household Under 19 Under 24 but a full-time student Over 19 and not a full-time student Over 24 Any age Any age Does not matter Does not matter Less than the exemption amount ($4,050 in 2017) Less than the exemption amount Less than the exemption amount Less than the exemption amount 6. The third step is adding up all of the taxpayer s income to determine gross income. The following list of examples is not exhaustive: 1. Compensation for services in whatever form received 2. Gross income from business (after reasonable and necessary business expenses are deducted) 3. Gains from dealings in property (the amount received from the buyer less basis) 4. Interest 5. Rents (less any reasonable and necessary expenses incurred to produce the rental income) 6. Royalties 7. Dividends 8. Alimony and separate maintenance payments received 9. The income portion of annuity payments 10. Income from life insurance and endowment contracts 11. Pensions 12. Income from the discharge of debt 13. A partner s share of partnership income (also shareholders in an S corporation) 14. Income in respect of a decedent 15. Income from an interest in an estate or trust 16. Unemployment compensation 2017 Keir Educational Resources 8 www.keirsuccess.com

Income Tax Planning Summary Review Chapter One While gross income tends to be all-inclusive, certain items that might be considered income are in fact exclusions and are not included in the calculation of gross income for federal income tax purposes. Some types of income cited in the Tax Code as nontaxable include: 1. Death proceeds from life insurance 2. Benefits paid from a life insurance policy to those who are terminally ill 3. Return of investment on an annuity contract 4. Workers compensation payments 5. Damages received because of personal physical injury or illness (though, not punitive damages) 6. Reimbursement by insurance or an employer plan for medical expenses (unless deducted in a previous year) 7. Amounts paid for health insurance under a nondiscriminatory plan by an employer 8. Amounts withdrawn from MSAs or HSAs to pay medical expenses 9. Benefits provided under a cafeteria plan 10. Employer-paid educational assistance up to $5,250 11. Employer-provided child care up to $5,000 12. Other fringe benefits 13. Meals and lodging provided on the employer s premises for the convenience of the employer and as a condition of employment 14. Gifts or bequests 15. Interest on municipal bonds 16. Scholarships and fellowships 17. Gain on the sale of a residence 18. A portion of Social Security benefits 19. Child support received 7. It should also be noted that a taxpayer s gross income is reduced by losses resulting from the taxpayer s capital transactions, business activities, or farm operations. Deductions from gross income for capital losses are limited to a maximum of $3,000 per year. However, any loss in excess of $3,000 may be carried over to future years. 8. Separate schedules are required for: (1) the calculation of capital gains or losses, (2) business income or loss, (3) farm income or loss, and (4) taxable income from pensions, Social Security benefits, rents, royalties, and partnerships. 9. After determining gross income, the fourth step, is subtracting specified adjustments, to arrive at adjusted gross income (AGI). AGI is an intermediate step in the calculation of taxable income, which is used by individuals, but not corporations. Adjusted gross income is of major importance because it is used to determine the limits on itemized deductions for medical expenses, casualty losses, and charitable contributions and for Tier II itemized deductions. AGI is also used to determine whether deductible contributions can be made to a regular IRA and whether any contributions can be made to a Roth IRA. Additionally, AGI is the number used to begin calculating taxpayer s alternative minimum tax. (Calculating the alternative minimum tax will be covered later.) AGI is also used in calculating the phaseout of itemized deductions, phaseout of personal exemptions, passive activity losses, and interest exemptions from certain U.S. savings bonds. 2017 Keir Educational Resources 9 800-795-5347

Income Tax Planning Summary Review Chapter One 10. The adjustments that are used to convert gross income to AGI in 2017 include the following: (1) IRA deductions of up to $5,500 per taxpayer (plus an additional $1,000 for taxpayers over 50) (2) Student loan interest up to $2,500 (3) Moving expenses (unreimbursed by the employer) (4) 50% of self-employment taxes (based upon a combined 15.3% S.S. and Medicare tax)* (5) 100% of self-employed health insurance premiums (6) Self-employed contributions to SEP, SIMPLE, or qualified plans (7) Medical savings account (MSA) or health savings account (HSA) contributions (8) Penalty on the early withdrawal of savings (not 10% early withdrawal penalty on retirement accounts) (9) Alimony paid (10) Certain business expenses of reservists, performing artists, and fee-basis government officials (11) Domestic production activities. The deduction is up to 6% of qualified production activities income (deduction based on the taxpayer s AGI and no more than 50% of wages). (12) Up to $4,000 of qualified education expenses (tuition and fees). (13) Up to $250 of classroom expenses for teachers of K-12. * The deduction is based upon the employer s portion of the combined S.S. and Medicare taxes (6.2% Social Security and 1.45% Medicare). In December 2004, Congress passed new legislation that created health savings accounts (HSA). HSAs allow insureds covered under high-deductible health plans to make tax-deductible contributions to a health savings account. A high-deductible health plan for a family has an annual deductible of at least $2,600 and a limit on annual expenses of up to $13,100 in 2017. For an individual plan, the cost of deductible and the annual expenses under the plan is between $1,300 and $6,550 in 2017. Since the contributions are an above-the-line deduction for AGI, taxpayers do not need to itemize to benefit from HSAs. In 2017, deductible contributions are limited to $3,400 and $6,750 for individual or family coverage, respectively. People who are 55 or older but less than 65 may contribute an additional $1,000 for 2017. Those enrolled in Medicare get no deduction. Earnings on the contributions to HSAs are not taxed currently, and distributions used to pay for qualifying medical expenses are tax-free. The above-the-line deductions for interest on education loans, IRA contributions, and qualified tuition and fees are discussed in more detail to follow. 11. In 1997, Congress added a new adjustment to gross income for interest paid on qualified education loans. The loans must be incurred for tuition, fees, room and board, books, supplies, and related expenses for higher education. The maximum deduction is $2,500. The loans can be taken for higher education for the taxpayer and his or her spouse or dependents. For 2017, this deduction is phased out for taxpayers filing jointly with AGIs between $135,000 and $165,000 and between $65,000 and $80,000 for singles. 2017 Keir Educational Resources 10 www.keirsuccess.com

Income Tax Planning Summary Review Chapter One 12. The full IRA deduction, namely, the lesser of a taxpayer s earned income or $5,500 per year, may be claimed by taxpayers who are not active participants in an employer-maintained retirement plan. An individual can now take a full deduction for a regular IRA even if his or her spouse is an active participant in an employer s retirement plan, provided the couple s joint income is less than $186,000. The same full deduction may be claimed when both taxpayers are participants in an employer retirement plan if their incomes are below certain levels. The limiting AGI level for the maximum $5,500 deduction is $62,000 for a single taxpayer and $99,000 for a married couple filing jointly for 2017. For taxpayers over 50, the maximum is $6,500 in 2017, due to a $1,000 catch-up provision. Contributions to Roth IRAs are not deductible at any income level. However, even without a deduction for contributions, Roth IRAs are powerful savings vehicles, and distributions, as a rule, are tax-free (not just tax-deferred as for regular IRAs). An individual s contribution to all IRAs is limited to $5,500 per person (except for those over 50, who can contribute $6,500). For Roth IRAs, the possible $5,500 limit is phased out for singles with AGIs between $118,000 and $133,000, and for joint filers with AGIs between $186,000 and $196,000 in 2017. These Roth IRA limits are without regard to active participant status. 13. A partial IRA deduction (again, only for regular IRAs) is available to taxpayers covered by an employer-maintained retirement plan, when their AGIs are in the $62,000 to $72,000 range for singles and heads of a household; in the $99,000 to $119,000 range for married filing jointly; and in the zero to $10,000 range for married filing separately. These phaseout ranges are for 2017, and they change each year, subject to inflation adjustments. 2017 Keir Educational Resources 11 800-795-5347

Chapter One Income Concepts Basic Terminology and Tax Calculation 1. Common types of gross income found in the Internal Revenue Code (IRC) are of all the following, EXCEPT: (K. para. 6) A. Wages, salaries, fees, and commissions B. Net income from a business C. Gains from buying and selling property D. Interest income from most municipal bonds E. Bank interest received on a savings account 2. All of the following are includible in an individual taxpayer s gross income for federal income tax purposes, EXCEPT: (K. para. 6) A. Rents and royalties B. Dividends on life insurance policies C. Cash dividends on stock in a domestic corporation D. Pension payments by a former employer E. Capital gain from the sale of tax-exempt bonds 3. Which of the following is includible in gross income for federal income tax purposes? (K. para. 6) A. Gift from a grandfather to pay tuition B. A year-end bonus received by an employee, based on business profits C. Excess living expenses received under an insurance contract after a home was damaged by fire D. Interest paid on most bonds issued by a state or political subdivision E. Child support payments received from an ex-spouse 4. The term gross income includes all of the following, EXCEPT: (K. para. 6-8) A. All income from whatever source derived, unless specifically excluded by the Internal Revenue Code B. Gain derived from capital, labor, or both C. Gain from the sale of most municipal bonds D. Stock purchased at $20 a share but now worth $50 a share E. Commissions received for selling tax-exempt securities 5. All of the following statements concerning adjusted gross income (AGI) are correct, EXCEPT: (K. para. 9-10) A. It is used to ascertain the limitation on an individual s deduction for charitable contributions. B. It is determined by subtracting allowable deductions from gross income. C. It is the base figure for determining the deduction allowed for medical expenses. D. It is equally applicable to individuals and corporations. E. It provides a base for the calculation of the alternative minimum tax. 2017 Keir Educational Resources 12 800-795-5347

Income Tax Planning Multiple Choice Questions Chapter One APPENDIX I 2017 TAX STRUCTURE Taxable Income Head of Tax Rates (1) Single Married Joint Married Separate Household 10% 15% 25% 28% 33% 35% 39.6% 0-9,325 9,325-37,950 37,950-91,900 91,900-191,650 191,650-416,700 416,700-418,400 over 418,400 0-18,650 18,650-75,900 75,900-153,100 153,100-233,350 233,350-416,700 416,700-470,700 over 470,700 0-9,325 9,325-37,950 37,950-76,550 76,550-116,675 116,675-208,350 208,350-235,350 over 235,350 0-13,350 13,350-50,800 50,800-131,200 131,200-212,500 212,500-416,700 416,700-444,550 over 444,500 Std. Deduct. (2) $ 6,350 $ 12,700 $ 6,350 $ 9,350 Add l. Deduct. (3) $ 1,550 $ 1,250 $ 1,250 $ 1,550 Personal Exempt. $ 4,050 $ 4,050 $ 4,050 $ 4,050 Estates & Trusts N/A 0-2,550 2,550-6,000 6,000-9,150 9,150-12,500 N/A over 12,300 (1) Maximum tax rate on net long-term capital gains and qualified dividends is 15% for most taxpayers (0% if the taxpayer is in the 10% or 15% marginal tax bracket, 20% if the taxpayer is in the 39.6% marginal bracket) (2) The standard deduction for a dependent is the greater of $1,050 or $350 plus earned income. The standard deduction for the dependent shall not exceed the standard deduction of a single taxpayer, which is $6,350. (3) Each instance of blindness or being age 65 or older APPENDIX II 2016 TAX STRUCTURE Taxable Income Head of Tax Rates (1) Single Married Joint Married Separate Household 10% 15% 25% 28% 33% 35% 39.6% 0-9,275 9,275-37,650 37,650-91,150 91,150-190,150 190,150-413,350 413,350-415,050 over 415,050 0-18,550 18,550-75,300 75,300-151,900 151,900-231,450 231,450-413,350 413,350-466,950 over 466,950 0-9,275 9,275-37,650 37,650-75,950 75,950-115,725 115,725-206,675 206,675-233,475 over 233,475 0-13,250 13,250-50,400 50,400-130,150 130,150-210,800 210,800-413,350 413,350-441,000 over 441,000 Estates & Trusts N/A 0-2,550 2,550-5,950 5,950-9,050 9,050-12,400 N/A over 12,400 Std. Deduct. (2) $ 6,300 $ 12,600 $ 6,3000 $ 9,300 Add l. Deduct. (3) $ 1,550 $ 1,250 $ 1,250 $ 1,550 Personal Exempt. $ 4,050 $ 4,050 $ 4,050 $ 4,050 (1) Maximum tax rate on net long-term capital gains and qualified dividends is 15% for most taxpayers (0% if the taxpayer is in the 10% or 15% marginal tax bracket, 20% if the taxpayer is in the 39.6% marginal bracket) (2) The standard deduction for a dependent is the greater of $1,050 or $350 plus earned income. The standard deduction for the dependent shall not exceed the standard deduction of a single taxpayer which is $6,300. (3) Each instance of blindness or being age 65 or older 2017 Keir Educational Resources 13 800-795-5347

Chapter One Income Concepts Basic Terminology and Tax Calculation 1. D is the answer. Under the IRC, the interest on tax-exempt bonds (most municipal bonds) is excluded from gross income. In contrast, wages, salaries, commissions, fees, business income, gain from the sale of property, dividends, and most interest payments are part of gross income inasmuch as they are not specifically excluded. 2. B is the answer. Dividends on life insurance are deemed a nontaxable return of premium and are not included in a taxpayer s gross income. The other items are included in taxable income. 3. B is the answer. Specifically excluded from gross income are, among many others, interest on most municipal bonds, excess living expenses incurred because of a casualty, and gifts. (Excess living expenses are costs following a casualty, in addition to usual living expenses: e.g., hotel costs while a fire-damaged home is being repaired (and the mortgage must still be paid). Almost all bonuses are included in the definition of gross income. 4. D is the answer. Gross income is truly an inclusive term inasmuch as it encompasses all income except those items that are specifically excluded. Among the excluded items is the interest from taxexempt bonds (most municipal bonds). Note that an increase in the value of property, such as stocks, bonds, real estate, etc., is not considered income until the property is sold. 5. D is the answer. Adjusted gross income is of major importance in determining the allowable deductions from AGI for charitable contributions, casualty losses, and medical expenses. It is also used in some instances in the calculation of amounts that can be deducted for contributions to an Individual Retirement Account. AGI, in addition, provides a base for the calculation of the alternative minimum tax. AGI is used by individuals but is not used in the calculation of corporate taxable income. 2017 Keir Educational Resources 14 800-795-5347