chapter 4

Personal Finance: Turning Money into Wealth, 7e (Keown) Chapter 4 Tax Planning and Strategies 4.1 The Federal Income Tax Structure 1) Currently, the highest tax bracket for taxpayers is 37.5 percent. Answer: FALSE Diff: 2 Topic: Tax Rates AACSB: Reflective Thinking 2) Compared to the standard deduction, it is easier to calculate your itemized deductions. Answer: FALSE Diff: 2 Topic: Deductions AACSB: Analytical Thinking 3) Your deductions as a single person have reduced your taxable income to $38,950, bringing you into the 25 percent tax bracket. As such, your taxes will amount to 25 percent of your taxable income of $38,950. Answer: FALSE Diff: 3 Topic: Tax Rates AACSB: Analytical Thinking 4) Taxes are collected on a pay-as-you-go basis. Answer: TRUE Diff: 2 Topic: Progressive Tax AACSB: Analytical Thinking 5) You pay taxes only when you sell stock and realize the gain. Answer: TRUE Diff: 3 Topic: Capital Gains/Loss AACSB: Analytical Thinking 6) According the Keown book, most taxes, about 30 percent of individual income taxes, are collected through withholding from wages. Answer: FALSE Diff: 3 Topic: Taxes AACSB: Analytical Thinking 1 Copyright © 2016 Pearson Education, Inc. 7) In 2013 you purchased $1,800 of IBM stock and you sold it this year for $1,500. Since you lost money on this transaction, there is no valid reason to include this on this year's tax return. Answer: FALSE Diff: 3 Topic: Capital Gains/Loss AACSB: Analytical Thinking 8) In 2010 you purchased a share of stock for $125 and you sold it this year for $250. Legally, you don't need to pay any taxes on this transaction. Answer: FALSE Diff: 3 Topic: Capital Gains Tax AACSB: Analytical Thinking 9) Adjusted gross income is your total gross income adjusted for inflation. Answer: FALSE Diff: 1 Topic: Adjusted Gross Income AACSB: Analytical Thinking 10) Bracket creep refers to an increase in marginal taxes caused by the impact of inflation. Answer: TRUE Diff: 2 Topic: Tax Brackets AACSB: Analytical Thinking 11) Only people in the higher tax brackets pay taxes on capital gains. Answer: FALSE Diff: 3 Topic: Capital Gains Tax AACSB: Analytical Thinking 12) For most tax payers, their average tax rate is lower than their marginal tax rate. Answer: TRUE Diff: 3 Topic: Marginal Tax Rate AACSB: Analytical Thinking 13) If you are in a 25 percent tax bracket then every dollar of your adjusted gross income will be taxed at 25 percent. Answer: FALSE Diff: 3 Topic: Progressive Tax AACSB: Analytical Thinking 2 Copyright © 2016 Pearson Education, Inc. 14) A regressive tax rate is one that increases as you make more income. Answer: FALSE Diff: 1 Topic: Progressive Tax AACSB: Analytical Thinking 15) The impact of taxes are an important consideration in most of the financial decisions that you will make. Answer: TRUE Diff: 1 Topic: Taxes Affect Personal Finance Decisions AACSB: Reflective Thinking 16) Ashlyn is a single person with no dependents. She normally receives over $1,800 every year for an income tax refund. She is having difficulty paying her monthly bills every month. What tax advice would you give her? A) She should increase her exemptions on her W-4 form at work. B) She should pay her estimated taxes every quarter. C) She needs to find some more tax deductions. D) She needs to file as Head of Household status Answer: A Diff: 3 Topic: Taxes Affect Personal Finance Decisions AACSB: Analytical Thinking 17) The movement into a higher tax bracket as a result of inflation increasing wages is called A) bracket climbing. B) bracket migration. C) bracket creep. D) bracket shifting. Answer: C Diff: 1 Topic: Tax Brackets AACSB: Analytical Thinking 18) If you are an unmarried taxpayer, with at least one child or dependent living with you, your filing status should be A) single. B) surviving spouse. C) married filing separately. D) head of household. Answer: D Diff: 2 Topic: Taxes AACSB: Analytical Thinking 3 Copyright © 2016 Pearson Education, Inc. 19) Assets you own, including such items as stocks, bonds, or real estate, are commonly termed A) capital assets. B) monetary assets. C) current assets. D) intangible assets. Answer: A Diff: 1 Topic: Capital Asset AACSB: Analytical Thinking 20) Income on which the payment of taxes is postponed until some future date is called A) tax-delayed. B) tax-deferred. C) tax-postponed. D) tax-tardy. Answer: B Diff: 1 Topic: Tax-Deferred AACSB: Analytical Thinking 21) The percentage of the last dollar you earn that goes toward your taxes is your A) tax deferral rate. B) base tax rate. C) average tax rate. D) marginal tax rate. Answer: D Diff: 2 Topic: Tax Rates AACSB: Analytical Thinking 22) Deductions calculated using the federal tax form "Schedule A" which are totaled and then subtracted from taxable income are called A) itemized deductions. B) standard deductions. C) personal expenditures. D) personal exemptions. Answer: A Diff: 2 Topic: Deductions AACSB: Analytical Thinking 4 Copyright © 2016 Pearson Education, Inc. 23) An IRS-allowed reduction in your income for yourself, your spouse, and any dependents that is subtracted before you compute your taxes is called a(n) A) itemized exemptions. B) standard exemptions. C) marital exemptions. D) personal exemptions. Answer: D Diff: 1 Topic: Deductions AACSB: Analytical Thinking 24) Expenditures that are subtracted in an effort to calculate the lowest possible taxable income are called A) exemptions. B) deductions. C) capital expenses. D) fixed expenses. Answer: B Diff: 1 Topic: Deductions AACSB: Analytical Thinking 25) A tax system in which tax rates increase as income increases is called a(n) ________ system. A) progressive tax B) universal tax C) regressive tax D) prorated tax Answer: A Diff: 1 Topic: Progressive Tax AACSB: Analytical Thinking 26) Three years ago you purchased a share of CompUTech stock for $32, which you could sell today at the current market price of $252. What would be your capital gain on the sale, ignoring commissions? A) $32 B) $220 C) $252 D) $284 Answer: B Diff: 3 Topic: Capital Gains/Loss AACSB: Analytical Thinking 5 Copyright © 2016 Pearson Education, Inc. 27) You purchased 100 shares of I-Tech stock for $40 per share 3 years ago. If you sold those shares today at the current market price of $150 per share, what would be your capital gain on the sale, ignoring all commissions? A) $110 B) $3,667 C) $7,333 D) $11,000 E) None of the above Answer: D Diff: 3 Topic: Capital Gains/Loss AACSB: Analytical Thinking 28) Five years ago, you purchased 200 shares of Go-Tech stock for $25 per share. If you sold those shares today at the current market price of $90 per share, what would be your capital gain on the sale, ignoring all commissions? A) $115 B) $4,290 C) $8,710 D) $13,000 Answer: D Diff: 3 Topic: Capital Gains/Loss AACSB: Analytical Thinking 29) Assume that you have a marginal tax rate of 28 percent, a state income tax rate of 4 percent, and have a city income tax rate of 1 percent. The tax for Social Security and Medicare is 7.65 percent. What would be the effective marginal tax rate on your last dollar of earnings? A) 28 percent B) 32 percent C) 33 percent D) 40.65 percent E) Cannot determine from the information provided Answer: D Diff: 3 Topic: Tax Rates AACSB: Analytical Thinking 6 Copyright © 2016 Pearson Education, Inc. 30) According the Keown book, most taxes–about ________ of individual income taxes–are collected through withholding from wages. A) 30 percent B) 50 percent C) 70 percent D) 90 percent Answer: C Diff: 2 Topic: Taxes AACSB: Analytical Thinking 31) You and spouse are filing a joint return. Your current deductions have reduced your taxable income to $88,990, bringing you into the 25 percent tax bracket. The first dollars you earned will be taxed at the ________ tax bracket. A) 10 percent B) 15 percent C) 25 percent D) 33 percent Answer: A Diff: 2 Topic: Tax Brackets AACSB: Analytical Thinking 32) According to the Tax Policy Center, approximately ________ of American households did not pay any federal income taxes in the 2013 tax year. A) 15 percent B) 25 percent C) 33 percent D) 43 percent Answer: D Diff: 2 Topic: Tax Rates AACSB: Analytical Thinking 33) You and spouse are filing a joint return. Your current deductions have reduced your taxable income to $88,990, bringing you into the 25 percent tax bracket. The last dollars you earned will be taxed at the ________ tax bracket. A) 10 percent B) 15 percent C) 25 percent D) 33 percent Answer: C Diff: 2 Topic: Tax Brackets AACSB: Analytical Thinking 7 Copyright © 2016 Pearson Education, Inc. 34) Which of the methods listed below is not used by the IRS as a tax collection mechanism? A) Paycheck withholdings B) Audits held in your home or office C) Quarterly estimated tax payments D) Payments sent with your tax return E) All of the above are used by the IRS to collect income taxes. Answer: B Diff: 2 Topic: Taxes AACSB: Analytical Thinking 35) Wilma Rudolph was given a cost of living raise and a merit raise at work this year. Her federal income taxes will be paid at 25% instead of 15%. Wilma has experienced A) bracket creep. B) the inflation trap. C) a capital gain. D) a higher personal exemption rate. E) an opportunity to change her filing status. Answer: A Diff: 2 Topic: Tax Brackets AACSB: Analytical Thinking 36) Craig Ripley sold his stock in Gandy Corporation for a price less than what he paid for it. Craig will experience A) a capital loss tax. B) a capital gains tax. C) a capital gain. D) a capital loss. E) bracket creep. Answer: D Diff: 2 Topic: Capital Gains/Loss AACSB: Analytical Thinking 37) Contributing $2,000 into a tax-deferred retirement plan in a 28% tax bracket will save A) $70. B) $140. C) $280. D) $560. E) It depends on the exemptions and deductions claimed. Answer: D Diff: 3 Topic: Tax-Deferred AACSB: Analytical Thinking 8 Copyright © 2016 Pearson Education, Inc. 38) Which of the following is an income tax filing status? A) Divorced filing spouse B) Married filing jointly and surviving spouses C) Head of divorced household D) All of the above are income tax filing statuses. Answer: B Diff: 2 Topic: Taxes AACSB: Analytical Thinking 39) The amount of income taxes that you actually pay is based upon your A) taxable income. B) adjusted gross income. C) gross income. D) taxable income minus exemptions and deductions. Answer: A Diff: 3 Topic: Taxable Income AACSB: Diverse and Multicultural Work Environments 40) Which of the following is not allowed as a personal or dependency exemption? A) Yourself B) Your 26-year-old child, who lives at home and earns $27,000 a year C) Your spouse, if you're filing a joint return D) Your 75-year-old grandfather, whom you financially support Answer: B Diff: 3 Topic: Deductions AACSB: Analytical Thinking 41) Why might someone choose to use itemized deductions instead of taking the standard deduction offered by the IRS? A) It is easier to calculate your itemized deductions versus the standard deduction. B) You may have a lower tax liability if you itemize instead of using the standard deduction. C) Married taxpayers must use the itemized deductions only. D) Most computer tax software automatically itemizes deductions. E) both B and C are correct. Answer: B Diff: 2 Topic: Deductions AACSB: Analytical Thinking 9 Copyright © 2016 Pearson Education, Inc. 42) Understanding how tax planning affects your personal finances is actually important for most taxpayers, not just the wealthy, because A) many people don't take advantage of all the deductions and tax credits they are entitled to. B) many people pay higher taxes or receive smaller refunds than they need to. C) the average American spends close to one-third of the year earning the money necessary to pay his or her taxes. D) only choices A and B. E) all of the above choices. Answer: E Diff: 2 Topic: Tax Planning AACSB: Analytical Thinking 43) Chase Cutter has a marginal tax rate of 33 percent, a state income tax rate of 3.5 percent, and a city income tax rate of 0.5 percent. The tax for Social Security and Medicare is 7.65 percent. What would be the effective marginal tax rate on your last dollar of earnings? A) 33 percent B) 36.5 percent C) 39.6 percent D) 44.65 percent Answer: D Diff: 3 Topic: Taxes AACSB: Analytical Thinking 44) Why is tax planning so important? Answer: Most people don't seem to understand tax planning and don't keep up with all the changes in tax law. Many pay several thousand dollars more in income taxes than they really need to. The average American spends over one-third of each year earning money to pay taxes. Planning is vital to pay your fair share and to keep your fair share, regardless of income. In sum, tax planning is not just for the wealthy. Diff: 1 Topic: Tax Planning AACSB: Analytical Thinking 45) Name the categories of filing status. Answer: Single status, married filing jointly or surviving spouse, married filing separately, and head of household. Diff: 1 Topic: Taxes AACSB: Analytical Thinking 10 Copyright © 2016 Pearson Education, Inc. 46) Explain the ways income taxes are paid or collected. Answer: Income taxes are generally paid as withholdings from paychecks. Other ways in which taxes are collected include quarterly estimated taxes sent to the IRS, payments with tax returns, and direct withholdings from stock dividends, retirement funds, and prizes or gambling winnings. Diff: 1 Topic: Taxes AACSB: Diverse and Multicultural Work Environments 47) Describe the four filing status classifications. Answer: Married Filing Jointly and Surviving Spouses: You file a joint return with your spouse, combining incomes and deductions into a single return. If your spouse dies, you can still qualify for this status for up to two years after the year in which your spouse died if you have a dependent child living with you, you pay more than half the cost of keeping up your home, and you are not remarried. Of course, if you remarry, you can file a joint return with your new spouse. Married Filing Separately: Married couples also have the choice of filing separately.It is hard to say ahead of time whether you will do better filing jointly or separately. The best idea is to figure your taxes both ways and, of course, go with the lower number. This status is often used when a couple is separated or in the process of getting a divorce. Head of Household: Head of household status applies to someone who is unmarried and has at least one child or relative living with him or her. The advantage of this status is that your tax rate will be lower and your standard deduction will be higher than if you had filed with single status. To qualify for head of household status, you must be unmarried on the last day of the tax year, have paid more than half the cost of keeping up your home, and have had a child or dependent live with you for at least half of the year. Diff: 3 Topic: Taxes AACSB: Reflective Thinking 4.2 Other Taxes 1) Social Security is a voluntary insurance program administered by the federal government that provides for you and your family in the event of death, disability, health problems, or retirement. Answer: FALSE Diff: 2 Topic: Social Security AACSB: Analytical Thinking 2) The Federal Insurance Contributions Act (FICA) tax deducted from your salary goes to pay for unemployment insurance. Answer: FALSE Diff: 2 Topic: Taxes AACSB: Diverse and Multicultural Work Environments 11 Copyright © 2016 Pearson Education, Inc. 3) If you are self-employed, you have to pay both the employer and employee portions of FICA, for a total rate of 20 percent. Answer: FALSE Diff: 2 Topic: Taxes AACSB: Analytical Thinking 4) Excise taxes A) are imposed on specific purchases, such as alcohol and cigarettes. B) are often aimed at reducing the consumption of the items being taxed. C) are referred to as "sin taxes" in some cases. D) all of the above. Answer: D Diff: 3 Topic: Tax Rates AACSB: Diverse and Multicultural Work Environments 5) FICA deductions from your paycheck are for which mandatory federal insurance programs? A) Unemployment benefits B) Social Security C) Medicare D) Medicaid E) Both B and C Answer: E Diff: 2 Topic: Social Security AACSB: Analytical Thinking 6) The FICA tax is typically deducted from your salary at a rate of ________until your salary reaches a point where it is no longer taxed at the rate of ________ for Social Security. A) 6.20 percent; 1.45 percent B) 7.65 percent; 6.20 percent C) 15.3 percent; 7.65 percent D) 20 percent; 10 percent Answer: B Diff: 3 Topic: Taxes AACSB: Analytical Thinking 12 Copyright © 2016 Pearson Education, Inc. 7) For 2014, the federal tax code allows an estate valued at up to $5.34 million to be transferred tax free to any heir. If the estate is valued at more than $5.34 million, the amount over $5.34 million will be taxed at A) 25 percent. B) 30 percent. C) 40 percent. D) 55 percent. Answer: C Diff: 3 Topic: Taxes AACSB: Analytical Thinking 4.3 Calculating Your Taxes 1) Tax credits reduce your taxes on a dollar-for-dollar basis. Answer: TRUE Diff: 2 Topic: Tax Credit AACSB: Analytical Thinking 2) Standard deductions need yearlong record-keeping and thorough and accurate documentation. Answer: FALSE Diff: 2 Topic: Deductible AACSB: Analytical Thinking 3) The health care premium credit is available to low-income taxpayers who purchased coverage through the Health Insurance Marketplace. Answer: TRUE Diff: 2 Topic: Tax Credit AACSB: Analytical Thinking 4) The Lifetime Learning tax credit is designed to help all taxpayers get at least a two-year degree. Answer: FALSE Diff: 3 Topic: Tax Credit AACSB: Reflective Thinking 5) A personal exemption is an approved deduction that you can make on your tax return for each person supported by the income shown on your tax return. Answer: TRUE Diff: 3 Topic: Deductions AACSB: Information Technology 13 Copyright © 2016 Pearson Education, Inc. 6) ________ income is from activities in which the taxpayer does not actively participate. A) Active B) Portfolio C) Passive D) Investment E) both C and D Answer: C Diff: 2 Topic: Taxable Income AACSB: Analytical Thinking 7) A child tax credit reduces the federal income tax you owe by up to $1,000 for each qualifying child under the age of A) 15. B) 17. C) 19. D) 21. Answer: B Diff: 2 Topic: Tax Credit AACSB: Analytical Thinking 8) Your dependent is claimed as an approved exemption on ________ tax return. A) your B) his or her own C) the return they choose themselves D) all of the above E) none of the above Answer: A Diff: 2 Topic: Deductions AACSB: Analytical Thinking 9) Which of the following statements about portfolio income from investments that are not held in a tax-deferred account, is accurate? A) It is also called investment income. B) It is normally in the form of dividends and interest. C) It must be reported on your tax return. D) It may be taxed at a lower rate than wages and salaries are. E) All of the above Answer: E Diff: 3 Topic: Taxable Income AACSB: Information Technology 14 Copyright © 2016 Pearson Education, Inc. 10) Who must file a federal income tax return? A) Everyone with an earned income during the year B) All heads of household C) All American citizens D) Individuals whose income meets federal guidelines E) Only those who have to file a state income tax return Answer: D Diff: 3 Topic: Taxes AACSB: Information Technology 11) Which of the following are permissible itemized tax deductions? A) Medical and dental expenses B) Casualty and theft losses C) Home mortgage interest D) Gifts to charity E) All of the above Answer: E Diff: 2 Topic: Deductions AACSB: Information Technology 12) From the list below choose the item that is not a permissible tax deduction. A) State, local, and real estate taxes B) Home equity loan interest on debt up to $100,000 C) Auto, truck, or van loan interest D) Interest on money borrowed to invest, within the IRS limits based on investment income E) Unreimbursed job-related expenses and tax preparation costs within the IRS limits Answer: C Diff: 3 Topic: Deductions AACSB: Information Technology 13) Which factors affect your choice between claiming itemized deductions and the standard deduction? A) Home ownership, as mortgage interest may exceed the standard deduction B) More deductible expenses this year than last year, as a result of unforeseen circumstances or planned "bunching" of deductions C) Ease and simplicity of filing D) Year long recordkeeping to thoroughly and accurately document itemized deductions E) All of the above Answer: E Diff: 3 Topic: Deductions AACSB: Information Technology 15 Copyright © 2016 Pearson Education, Inc. 14) Your base income tax liability can be determined by A) using the alternative minimum tax worksheet, aimed at preventing the wealthy from paying little or no taxes. B) using the IRS tax tables provided in the instruction booklet. C) using the IRS rate schedules for taxable incomes greater than $100,000. D) all of the above. E) none of the above. Answer: D Diff: 3 Topic: Taxable Income AACSB: Information Technology 15) The earned income credit serves as a negative income tax and is available to A) anyone with an earned income as opposed to passive income. B) low-income taxpayers. C) only head of household status filers. D) only senior citizens below the poverty line. Answer: B Diff: 2 Topic: Tax Credit AACSB: Information Technology 16) Danielle is a divorced single parent who is currently paying back a college loan, attending graduate school part-time, and working full-time earning $42,000. She has custody and provides all support for her child. Which of the following adjustments, deductions, or credits might apply to her? A) Adjustment for student loan interest B) Child tax credit C) Child and dependent care credit D) Lifetime learning tax credit E) All of the above Answer: E Diff: 3 Topic: Deductions AACSB: Analytical Thinking 17) You wish to make a charitable contribution of $2,000 to a qualified organization. You are currently in the 28 percent marginal tax bracket. By how much would this contribution lower your tax bill assuming your other itemized deductions exceed the standard deduction? A) $280.00 B) $560.00 C) $1,440.00 D) $2,000.00 Answer: B Diff: 3 Topic: Deductions AACSB: Analytical Thinking 16 Copyright © 2016 Pearson Education, Inc. 18) You and your spouse have earned salary and wages of $41,750. In addition you have municipal bond interest income of $600 and savings account and certificate of deposit interest income of $800. You paid a total of $600 in interest on your student loan. Using only this information, what is your adjusted gross income for tax purposes? A) $43,150 B) $42,550 C) $42,350 D) $41,950 Answer: D Diff: 3 Topic: Adjusted Gross Income AACSB: Analytical Thinking 19) Income that comes from wages or a business is called A) investment income. B) active income. C) passive income. D) portfolio income. Answer: B Diff: 1 Topic: Taxable Income AACSB: Information Technology 20) Which of the following would offset your tax liability in a direct dollar for dollar manner and may actually increase your tax refund beyond the amount paid during the tax year? A) Tax exemption B) Tax deduction C) Tax credit D) Tax adjustment Answer: C Diff: 1 Topic: Tax Credit AACSB: Information Technology 21) Leticia is a single person who makes $45,000 per year. This year she paid $2,000 in student loan interest, $1,500 in medical expenses, $7,200 in rent and $4,800 in car loan payments. She contributes $3,600 per year to her 401(k) plan at work. Give her some tax advice. A) Single people should always take the standard deduction. B) People who have medical expenses should always itemize their deductions. C) Calculate your taxes using both methods to see which provides a greater deduction. D) You should itemize if you pay interest, since interest of any kind is tax deductible. Answer: C Diff: 3 Topic: Taxes Affect Personal Finance Decisions AACSB: Reflective Thinking 17 Copyright © 2016 Pearson Education, Inc. Karen and Jeffrey Bosteins Karen and her husband, Jeffrey, are facing a new income tax situation this year. She is a corporate accountant and Jeffrey is an engineer. Their gross salaries total $89,000. Both graduated from four-year universities five years ago and are still paying off large student loans. She is now attending school part-time to prepare for the CPA exam. The Bosteins incurred considerable expenses in the process of adopting an infant this year, and they have the ongoing expense of daycare. In January of last year they closed on their new home. Although trained as an accountant, Karen's work has not involved income tax preparation. Help them consider the following questions. 22) Which of the following credits would not apply to the Bosteins? A) Adoption credit B) Health care premium credit (children's version) C) Child and dependent care credit D) Lifetime Learning tax credit Answer: B Diff: 3 Topic: Tax Credit AACSB: Analytical Thinking 23) Additional items that may reduce the Bosteins' tax burden might include A) the child credit. B) adjustment for the interest on their college loans. C) earned income credit. D) both A and B. Answer: D Diff: 3 Topic: Tax Credit AACSB: Analytical Thinking 24) The Bosteins A) have no dependents to declare. B) should use the married filing separately filing status. C) should calculate their taxes itemizing and taking the standard deduction to see which is greater. D) none of the above. Answer: C Diff: 3 Topic: Deductions AACSB: Information Technology 18 Copyright © 2016 Pearson Education, Inc. 25) With a growing family, Karen and Jeffrey know they should start investing more to provide for a secure future. Which of the following issues should they consider as they plan? A) Interest paid on money borrowed to invest is an itemized deduction. B) Contributions to tax-deferred retirement accounts avoid taxes in the current year and grow tax-free until the time of withdrawal. C) Qualified dividends and capital gains are taxed at a lower rate than ordinary income. D) Municipal bond earnings are exempt from federal income tax. E) All of the above Answer: E Diff: 3 Topic: Tax Planning AACSB: Reflective Thinking 26) Since their taxes are becoming more complex, Jeffrey and Karen are concerned about making a mistake or getting audited. They should A) consult IRS Publication 17, Your Federal Income Tax, the IRS toll-free "hotline," or one of the self-help tax publications to learn more about their tax situation. B) choose an independent tax specialist to prepare their taxes, because there is more consistency in their training and the quality for their work than that of nationally affiliated specialists. C) remember that the key to winning an audit is good records to verify the tax form information. D) Only choices A and C. E) All of the above choices. Answer: D Diff: 3 Topic: Taxes AACSB: Reflective Thinking 19 Copyright © 2016 Pearson Education, Inc. Joseph Imamura For many years Joseph paid someone else to file his income tax return. After taking a personal finance course at his local college, Joseph feels he is ready to tackle it on his own for tax year 2014. Joseph is single with an income of $43,000 and has no dependents. He has little interest income from savings, does not have a personal IRA, and plans to itemize deductions. Joseph owns a home and travels a lot with his job. He pays some of his own work-related expenses because his employer does not pay for all of them. His only personal investments include 1,500 shares of stock he inherited from his uncle, which he does not intend to sell for many years because the blue-chip company has a strong history of dividend income and share price appreciation. However, he does contribute monthly to his 401(k) plan at work. 27) To help Joseph with his tax planning, he should carefully track and maintain records for all of the following expenses during the tax year except A) all expenses for prescribed health care needs that are not covered by insurance. B) all job related expenses, especially those that are and are not reimbursed by his employer. C) state and local income taxes, real estate taxes, and personal property taxes. D) price appreciation, or increases from January 1 to December 31, for the 1,500 shares of stock he owns. E) all of the above. Answer: D Diff: 3 Topic: Capital Gains/Loss AACSB: Analytical Thinking 28) Which of the following tax planning strategies could Joseph consider to reduce his future tax bills? A) Carefully track and maintain records for all itemized deduction categories to insure he is maximizing his itemized deductions. B) Establish a home equity credit line to finance other consumer credit, such as an auto purchase. C) Contribute as much as possible to a tax-deferred retirement account, such as his 401(k). D) Invest in municipal bonds to receive tax-exempt income. E) All of the above would be strategies available to Joseph to reduce his future taxes. Answer: E Diff: 3 Topic: Taxes AACSB: Analytical Thinking 20 Copyright © 2016 Pearson Education, Inc. 29) Joseph can qualify for all of the following except the A) mortgage interest payments deduction. B) deduction for unreimbursed job-related expenses that are in excess of 2 percent of AGI. C) Lifetime Learning Credit. D) real estate property taxes deduction. E) Joseph can qualify for all of the above to reduce his tax liability. Answer: C Diff: 3 Topic: Deductions AACSB: Analytical Thinking Samuel Ahn Samuel Ahn recently graduated from college and started working in a promising career field. He has a little money invested in a stock that pays no dividends. He lives in an apartment, is single, and has no dependents. He has a $22,000 student loan balance and he paid $800 interest in 2014. He is considering going back to school part-time for some additional computer classes. He does not have a personal IRA, and he contributed 2 percent of his $39,500 salary to his employer's 401(k) plan in 2014. As he completes his tax return for 2014, use the information above and below to help him answer the following questions. Standard deduction for 2014: $6,200 Personal exemption for 2014: $3,950 Tax brackets for 2014: Taxable income range Tax rate Up to $9,075 10 percent More than $9,075 but under $36,900 15 percent More than $36,900 but under $89,350 25 percent 30) What is Samuel's gross income for 2014? A) $35,250 B) $22,500 C) $39,500 D) Not enough information to determine Answer: C Diff: 1 Topic: Taxes AACSB: Analytical Thinking 21 Copyright © 2016 Pearson Education, Inc. 31) What is Samuel's adjusted gross income for 2014? A) $39,500 B) $32,500 C) $37,910 D) $38,700 Answer: C Diff: 2 Topic: Adjusted Gross Income AACSB: Analytical Thinking 32) What is Samuel's taxable income for 2014? A) $38,700 B) $29,350 C) $33,300 D) $27,760 Answer: D Diff: 3 Topic: Taxable Income AACSB: Analytical Thinking 33) What is Samuel's total tax liability for 2014? A) $5,351.25 B) $3,710.25 C) $4,541.25 D) $3,948.75 Answer: B Diff: 3 Topic: Marginal Tax Rate AACSB: Analytical Thinking 34) What is Samuel's marginal tax rate for his current level of taxable income? A) 10% B) 15% C) 12.5% D) 25% Answer: B Diff: 1 Topic: Marginal Tax Rate AACSB: Analytical Thinking 22 Copyright © 2016 Pearson Education, Inc. 35) Samuel's average tax rate for 2014 is closest to which of the following? A) 10% B) 15% C) 12.5% D) 25% Answer: A Diff: 3 Topic: Marginal Tax Rate AACSB: Analytical Thinking 36) Based on Samuel's completed tax return, what advice would you give him to lower his tax liability for 2015? A) He should take the computer classes in 2015. B) He should sell his stock. C) He should increase his contributions to the 401(k) plan at work. D) He should get a roommate and claim him as a dependant. E) Both A and C are good advice. Answer: E Diff: 3 Topic: Principle 4: Taxes affect personal finance decisions AACSB: Analytical Thinking 23 Copyright © 2016 Pearson Education, Inc. Richard and Katarina Bajorshik Katarina and Richard are a busy young couple with a son, Caleb, who is 6 and twin daughters, Stacy and Casey, who are actively exploring the world as four-year-olds. Before the twins were born, Katarina and Richard bought their first home with plenty of indoor and outdoor space for a growing young family. The Bajorshiks are concerned about their 2014 tax issues, but they are also committed to planning for the future of their family. Next year Richard should be able to pay off the remaining balance of his law school student loans. Contributing to Richard's Roth IRA is an annual priority. The following information reflects tax year 2014. Gross income Student loan interest Richard's traditional IRA Total itemized deductions Standard deduction for 2014 Personal exemption amount Marginal tax bracket $98,712 $1,965 $1,500 $12,000 $12,400 $3,950 25% 37) What is the Bajorshiks' adjusted gross income? A) $98,712 B) $97,212 C) $96,747 D) $95,247 E) $83,462 Answer: D Diff: 3 Topic: Adjusted Gross Income AACSB: Analytical Thinking 38) Approximately how much will the Bajorshiks save in 2014 income tax payments as a result of Richard's student loan interest? A) $1,965.00 B) $196.50 C) $491.25 D) $1,473.75 E) $0 Answer: C Diff: 3 Topic: Deductions AACSB: Analytical Thinking 24 Copyright © 2016 Pearson Education, Inc. 39) Richard and Katarina's filing status should be A) head of household. B) married filing jointly. C) married filing separately. D) single. E) surviving spouse. Answer: B Diff: 1 Topic: Taxes AACSB: Information Technology 40) What is Richard and Katarina's taxable income? A) $63,097 B) $63,497 C) $79,297 D) $83,247 E) $98,712 Answer: A Diff: 3 Topic: Taxable Income AACSB: Analytical Thinking 41) Although Richard and Katarina are a happily married couple, they joke that they could not possibly remarry for at least two years following the year of the death of the other spouse because A) the surviving spouse would lose the tax advantage of married filing jointly status, assuming at least one child was still a dependent and the surviving spouse was paying more than half the cost of keeping up the home. B) the surviving spouse would lose the exemption amount for the deceased spouse. C) the surviving spouse would have to file as head of household. D) neither spouse has sufficient life insurance to provide for the family. Answer: A Diff: 3 Topic: Taxes AACSB: Reflective Thinking 42) If the Bajorshiks' income does not exceed the phase-out level of $110,000 in 2014, by how much will the child tax credit reduce their tax liability? A) Their tax liability will be reduced by $750. B) Their tax liability will be reduced by $2,000. C) Their tax liability will be reduced by $2,100. D) Their tax liability will be reduced by $3,000. Answer: D Diff: 2 Topic: Tax Credit AACSB: Analytical Thinking 25 Copyright © 2016 Pearson Education, Inc. 43) Katarina worked as an ER nurse, and knows that demand for the job is high. However, prior to returning to work, when the twins enter kindergarten, she will need to take classes on the latest technological advancements. Which of the following tax planning strategies should the Bajorshiks consider as they plan their financial future? A) When Katrina returns to school, they should track school-related expenses and determine eligibility for the Lifetime Learning credit. B) While the children are under age 13, the Bajorshiks should track childcare expenses and determine eligibility for the child and dependent care credit. C) Both A and B are legitimate tax planning strategies that the couple should consider. D) Neither A nor B is a tax planning strategy that is relevant to this couple's situation. Answer: C Diff: 3 Topic: Tax Planning AACSB: Analytical Thinking 44) Name and describe the four general categories that reduce your taxable income, therefore reducing your tax liability. Answer: Adjustments to income allow certain legal reductions in gross income. Examples include IRA contributions, moving expenses, self-employment tax and retirement plans, and alimony payments. Itemized deductions consist of medical and dental expenses, state, local, and real estate taxes, home mortgage and investment interest payments, gifts to charity, theft and casualty losses, and miscellaneous deductions. As an alternative to itemizing deductions, the standard deduction may be used. Personal and dependency exemptions serve to further reduce taxable income. Finally, credits are subtracted directly from the tax liability, and while most credits are non-refundable, a few, such as the earned income credit allow for a refund in excess of taxes paid. Examples of credits include child and dependent care expenses, hope scholarship credit, lifetime learning credit, child credit, the earned income credit., adoption credit, and the health care premium credit. Note that the standard deduction amount and the exemption amount are adjusted upward annually in response to inflation. Diff: 2 Topic: Taxable Income AACSB: Reflective Thinking 45) Explain how to calculate your taxable income, and how to determine the need for a tax payment or refund. Answer: First, calculate total gross income by adding income from all taxable sources. Next, subtract all adjustments, deductions (the itemized or standard amount), and exemptions to calculate taxable income. On the basis of your taxable income, use the tax tables or tax rate to determine your tax liability and then apply any tax credits that may apply. If the amount of your tax liability is greater than the taxes withheld from you, then you owe the IRS a tax payment for the difference. If the tax liability is smaller than what was already withheld, then you are due a tax refund. Diff: 2 Topic: Taxable Income AACSB: Reflective Thinking 26 Copyright © 2016 Pearson Education, Inc. 46) Name the sources of tax-free income. Answer: These sources include interest on municipal bonds, tax-free money market funds, gifts, child support payments, welfare benefits, workers' compensation benefits, veterans' benefits, federal income tax refunds, certain Social Security benefits, interest earned inside a life insurance policy, earnings on an IRA, and inheritances. Diff: 1 Topic: Taxable Income AACSB: Information Technology 47) Explain the concept of using the standard deduction or using itemized deductions. Answer: The alternative to itemizing deductions is to take the standard deduction. The standard deduction is the best estimate by the government of what the average person would be able to deduct by itemizing. You don't need to figure your expenses and provide receipts or justification. The standard deduction varies based on your filing status. Many people have different situations that differentiates them from the average person. Diff: 2 Topic: Deductions AACSB: Analytical Thinking 48) Why are the various tax "credits" such a welcome relief? Answer: Tax credits are subtracted directly from taxes due on a dollar-for-dollar basis. The credits are not a deduction from income or a percentage of some entry in the tax form. Your final income tax liability represents your base income tax less your tax credits. The bottom line is a major savings in the tax burden. Diff: 2 Topic: Tax Credit AACSB: Information Technology 49) What combination of deductions and exemptions can the typical full-time college student who is employed during the summer, or perhaps during the school year, claim? Why? Answer: The typical employed full-time college student, who is claimed as a dependency exemption by his or her parents, can only claim the standard deduction to reduce tax liability. A dependency exemption cannot be claimed for anyone who earns more than the exemption amount. However, the income test does not apply to children under the age of 19 or to full-time college students under the age of 24. Finally, the parents must provide over half of the student's support. Given the relationship, income, support, and citizenship test, the parents can claim the dependent exemption. Because only one exemption can be claimed on any tax form, the typical full-time college student is limited to using the standard deduction to reduce his or her taxable income, and ultimately the tax liability. Diff: 3 Topic: Deductions AACSB: Analytical Thinking 27 Copyright © 2016 Pearson Education, Inc. 4.4 Other Filing Considerations 1) A key to calculating your taxes is deciding which Form 1050 to use: 1050EZ, 1050A, or 1050. Answer: FALSE Diff: 1 Topic: Taxes AACSB: Analytical Thinking 2) Form 1040EZ is aimed at those who have no dependents, whose taxable income is more than $100,000 per year, and who don't itemize their deductions. Answer: FALSE Diff: 2 Topic: Taxes AACSB: Analytical Thinking 3) Which of the following is an advantage of filing electronically? A) Faster refunds B) Quick electronic confirmation C) More accurate returns D) All of the above Answer: D Diff: 2 Topic: Taxes AACSB: Analytical Thinking 4) Free File is configured in a way that allows ________ of U.S. taxpayers who are eligible to use it. A) 25 percent B) 50 percent C) 70 percent D) 85 percent Answer: C Diff: 3 Topic: Taxes AACSB: Analytical Thinking 5) Which of the statements about audits is false? A) 1 percent of individual taxpayers are audited. B) 23.57 percent of individuals earning between $500,000 and $1 million are audited. C) 8.9 percent of individuals earning between $1 million and $5 million are audited. D) 27.37 percent of individuals earning more than $10 million are audited. Answer: B Diff: 3 Topic: Audit AACSB: Analytical Thinking 28 Copyright © 2016 Pearson Education, Inc. 6) Suppose that you are not able to complete your tax returns by April 15. Which of the following statements is most accurate? A) You must provide adequate need in tax court, requesting extension of the deadline. B) You can apply for an automatic extension — no questions asked, but you must enclose a check in payment for estimated taxes due. C) You may have an extension, and the taxes are not due until the extension expires. D) You do not have to pay interest on any taxes due on April 15, provided that you have filed for and have an approved extension prior to April 1 of the tax year. Answer: B Diff: 3 Topic: Taxes AACSB: Analytical Thinking 7) The deadline to file your income tax return is ________ although an automatic extension may be filed. A) March 15 B) March 30 C) April 15 D) April 30 Answer: C Diff: 1 Topic: Taxes AACSB: Analytical Thinking 8) If you are unable to file your tax returns by the deadline, you may file form 4868, Application for Automatic Extension of Time, and receive an extension of up to four months A) upon approval. B) automatically. C) if you meet the IRS requirements. D) none of the above Answer: B Diff: 2 Topic: Taxes AACSB: Analytical Thinking 9) If you made a mistake, an amended tax return may be filed on Form A) 1040. B) 1040A. C) 1040X. D) 1040ZX. E) 1040EZ. Answer: C Diff: 1 Topic: Taxes AACSB: Information Technology 29 Copyright © 2016 Pearson Education, Inc. 10) Which of the following is a reason or reasons for the IRS to audit your tax return? A) You were randomly selected as a matter of routine audits. B) You were audited in the past. C) There is something suspicious on your return. D) You earn a lot of money. E) any or all of the above Answer: E Diff: 2 Topic: Audit AACSB: Analytical Thinking 11) Six schedules are commonly used by taxpayers filing Form 1040. Give the title of each of these six basic schedules: A, B, C, D, E, EIC. Answer: Schedule A: Itemized Deductions Schedule B: Interest and Dividend Income Schedule C: Profit or Loss from Business Schedule D: Capital Gains and Losses Schedule E: Supplemental Income and Loss Schedule EIC: Earned Income Credit Diff: 2 Topic: Taxes AACSB: Reflective Thinking 12) What are the benefits of filing taxes electronically? Answer: Faster refunds: Direct deposit can speed refunds to e-filers in as few as 10 days. More accurate returns: IRS computers quickly and automatically check for errors or other missing information, making e-filed returns more accurate and reducing the chance of receiving an error letter from the IRS. Quick electronic confirmation: Computer e-filers receive an acknowledgment that the IRS has received their returns. Reduced paperwork and the use of electronic signatures: There is nothing to mail to the IRS. Diff: 3 Topic: Taxes AACSB: Analytical Thinking 4.5 Model Taxpayers: The Taylors File Their 2013 Return 1) In chapter 4, Dianne Taylor won a 2013 Honda Accord on "The Price is Right" TV show. She has to pay taxes on her prize. The taxes are based on the car's ________ value. A) fair market B) residual C) manufacturer's suggested retail price D) invoice Answer: A Diff: 3 Topic: Taxes AACSB: Analytical Thinking 30 Copyright © 2016 Pearson Education, Inc. 2) Gross income is another name for ________ income. A) expected B) total C) net D) value added Answer: B Diff: 3 Topic: Income Returns AACSB: Analytical Thinking 3) Which indicates the correct order for completing your tax returns? A) Claim exemptions, calculate total tax, subtract deductions, subtract adjustments, determine gross income B) Subtract deductions, calculate total tax, claim exemptions, determine gross income, subtract adjustments C) Determine gross income, subtract adjustments, subtract deductions, claim exemptions, calculate total tax D) None of the above Answer: C Diff: 3 Topic: Taxes AACSB: Analytical Thinking 4) For the Taylors, in chapter 4, they are allowed to take a tax credit of $1,000 per dependent child off of their A) total tax owed. B) exemptions counted. C) adjustments retained. D) net income. Answer: A Diff: 3 Topic: Taxes AACSB: Analytical Thinking 4.6 Tax Strategies to Lower Your Taxes 1) Claire currently makes $30,000 per year and is in a 15% tax bracket. If she contributes $1,800 to her 401(k) plan at work, by how much will this lower her tax liability? A) $270 B) $1,800 C) $4,500 D) $4,230 Answer: A Diff: 3 Topic: Taxes AACSB: Analytical Thinking 31 Copyright © 2016 Pearson Education, Inc. 2) Elizabeth currently makes $45,000 per year and is in a 25% tax bracket. If she contributes $2,400 to her 401(k) plan at work, by how much will this lower her taxable income? A) $7,500 B) $600 C) $2,400 D) $11,250 Answer: B Diff: 3 Topic: Deductions AACSB: Analytical Thinking 3) If you're in the 15% marginal tax bracket, what is the equivalent taxable yield on an 8% municipal bond? A) 9.41% B) 6.96% C) 8.15% D) 8.70% Answer: A Diff: 3 Topic: Deductions AACSB: Analytical Thinking 4) If you're in the 25% marginal tax bracket, what is the equivalent taxable yield on an 10% municipal bond? A) 11.76 B) 13.33 C) 4.00 D) 12.50 Answer: B Diff: 3 Topic: Deductions AACSB: Analytical Thinking 5) When considering a principal residence as a tax shelter, remember that you can A) purchase a house and deduct the mortgage interest. B) maintain and improve your home, as $500,000 of capital gains for couples and $250,000 of capital gains for single filers is exempt from taxation. C) take out a home equity loan to pay for other debts, such as auto financing. D) use all of these tax-saving strategies. E) only A and C. Answer: D Diff: 3 Topic: Taxes AACSB: Analytical Thinking 32 Copyright © 2016 Pearson Education, Inc. 6) Which of the following is a source of tax-free income? A) Welfare benefits B) Earnings on your IRA C) Federal income tax refunds D) Child support payments E) All of the above Answer: E Diff: 2 Topic: Taxable Income AACSB: Analytical Thinking 7) A source of tax-free income is A) interest on municipal bonds. B) inheritances. C) foreign income incurred by U.S. citizens living and working abroad. D) All of the above are sources of tax-free income. Answer: D Diff: 3 Topic: Taxable Income AACSB: Analytical Thinking 8) What are the five general tax strategies in tax planning? Answer: -Maximize your deductions. -Look to capital gains and dividend income, especially if you are in the top tax bracket. -Shift income to family members in lower tax brackets. -Seek out tax-exempt income. -Defer taxes to the future. Diff: 3 Topic: Tax Planning AACSB: Reflective Thinking 9) What are two tax advantages of tax-deferred retirement plans? Answer: (1) You don't pay taxes on the money you invest until such time as funds are withdrawn from the retirement account resulting in recognition of taxable income. (2) You don't pay interest on the earnings from your retirement account until such time as funds are withdrawn from the retirement account resulting in recognition of taxable income. Diff: 1 Topic: Tax Planning AACSB: Reflective Thinking 33 Copyright © 2016 Pearson Education, Inc. 10) Strategies for maximizing deductions center on what three tactics? Answer: (1) Using tax-deferred retirement programs to reduce taxes. (2) Using your home as a tax shelter. (3) Shifting and bunching deductions. Each of these tactics has the same goal: to reduce taxable income to its minimum level. Diff: 2 Topic: Deductions AACSB: Reflective Thinking 34 Copyright © 2016 Pearson Education, Inc.