Barbara A. Tyler, an FP in College Station, TX, has won the $2,000 prize in our taxquiz contest, which appeared in the Feb. 7 issue
Barbara A. Tyler, a family practitioner in College Station, TX, has won the $2,000 prize in our tax-quiz contest, which appeared in the Feb. 7 issue. Tyler says she enjoys learning about taxes, and she whipped through the quiz while watching TV. "Twenty years ago, when I was a bored Army wife, I took an H&R Block course, and I always do my own return," she says. "My husband has no interest in taxes."
Tyler's name was drawn at random from the 78 correct entries received. Interestingly, among the hundreds of entries with incorrect answers was one faxed from the office of a doctor's CPA.
The quiz concerned a fictitious coupleFP Jill Shield, a solo practitioner, and her schoolteacher husband, John. The questions and answers follow.
1 After the Shields moved last year, they borrowed $18,000 using an ordinary, unsecured bank line of credit. They used the money to put in a swimming pool at their new home, and they figure the interest will be a nifty tax deduction. Are they right?
a) Yes. This is similar to a home equity loan, and that interest is deductible.
b) Wrong. This kind of interest isn't deductible.
c) Wrong. A line of credit must exceed $20,000 to be deductible. Furthermore, the money can be used only for needed renovations, not something frivolous like a swimming pool.
Answer: b. The Shields are making a common mistake. Even though interest on a home equity loan or line of credit is deductible, bank credit-line interest isn't.
2 Jill Shield drives a car that's owned by her professional corporation. Eighty percent of the car's use is work-related, so she intends to deduct depreciation and other costs on her personal return. Is she right or wrong?
a) Right. It's a legitimate work-related expense.
b) Wrong. She can only deduct mileage.
c) Wrong. The corporation gets the deductions.
Answer:c. If Dr. Shield owned the car herself, she'd be entitled to the deductions.
3 Although John Shield began a sideline freelance photography business in 1998, he has yet to turn a profit. He invested a lot in camera and darkroom equipment, as well as in advertising. The couple intends to claim his losses. Is this risky?
a) Not if they take certain precautions.
b) Yes. Until he turns a profit, he can write off only half his expenses.
c) It's not a good idea. The IRS says you have to turn a profit in at least two years out of five to claim losses. John Shield's business is too young.
Answer:a. The IRS is suspicious of businesses that look like hobbies, such as photography. And it generally requires that you turn a profit in three years out of five to claim losses. Since John Shield hasn't been in business that long, he should consider filing Form 5213, a request to postpone a decision until enough years have passed to apply the three-out-of-five test. Meanwhile, the IRS will tentatively let him claim the losses.
4 Last summer, Jill Shield brought her husband along on a CME trip to Vancouver. They didn't add any vacation time, although John accompanied his wife when she drove, afterward, to a two-day conference outside Vancouver. Jill intends to deduct the rental car expenses and the full cost of the hotel room, for which she paid the double-occupancy rate. She won't claim the cost of her husband's meals. Is she correct?
a) Yes. She would have used the room and car even if her husband hadn't accompanied her, so those expenses are fully deductible.
b) No. She can deduct all the expenses, be-cause she was attending social events at the conference and was entitled to bring her husband with her.
c) No. She can deduct the full cost of the rental car, but only the single-occupancy rate for the room cost.
Answer: c. If the hotel charged a daily rate of $200 for double occupancy and $150 for a single guest, she can claim $150. It's correct to write off half the cost of her own meals.
5 John Shield inherited stock worth $50,000 last year. Eager to try his hand at trading, he sold his uncle's boring blue chips at a $10,000 gain and put the money into high-tech stocks. The couple is facing a tax bill on what amount?
a) $60,000. He should have spread the sale over several years, to avoid such a huge tax bite.
b) $10,000. He pays only on his gain.
c) Zero. He owes no tax, because it was an inheritance.
Answer: b. This is known as a "step-up in basis"you count the gain only from the time you inherit. What's more, although John might assume the tax due is about $3,600 (the Shield's are in the 36 percent bracket), a sale of an inheritance is automatically treated as long term, so he'll owe only $2,000, or 20 percent.
6 John was also the beneficiary of his uncle's IRA. The uncle made deductible contributions for many years. No taxes are due on this inheritance. Correct?
a) Yes, as long as the entire estate is less than $650,000.
b) Sure, because tax-free income is the whole point of IRAs.
c) No. Since the money wasn't taxed going in, it's taxed coming out.
Answer: c. The government expects its share, one way or another.
7 After driving to her office one morning, Jill Shield bumped her car into a gatepost in her practice's parking lot and sustained $650 worth of damage. She doesn't want to file an insurance claim, but she intends to write off the entire repair expense on her tax return, since she uses the car for business. Correct?
a) Good idea. The more insurance claims you file, the higher your premiums.
b) No. The IRS won't accept writeoffs for expenses that are covered by insurance, whether or not a claim is filed.
c) No. She can only write off the percentage of the repair that's proportional to her business use of the car.
Answer:b. However, the IRS does allow taxpayers to write off a portion of the repair cost equal to the policy's deductible, since they'd have to pay that much, anyway. The Shields' deductible is $500, and Jill Shield can write off the percentage that corresponds to her professional use of the car. That's 80 percent, so her business casualty loss is $400.
8 The custodial account the Shields opened when their daughter was born has grown to a tidy sum of $18,000. Jenny is now 11, so her parents assume that all of the account's earnings will be taxed at her rate of 15 percent. Correct?
a) That's right. The IRS goes easy on kids' money.
b) No. After a standard deduction of $700, only the next $700 of investment income is taxed at the kids' rate.
c) No. The first $500 of income is tax-free; the balance is taxed at the kids' rate.
Answer: b. The income in excess of $1,400 will be taxed at the parents' rate. If Jenny also has capital gains, a 10 percent rate will apply to those.
9 The Shields attended fund-raising dinners and concerts for charities during the year. They intend to deduct their donations, minus the value of the dinners and concerts. Are they splitting hairs?
a) No, that's what the IRS requires.
b) Yes. They can deduct the full amount they spent, though they'd be limited to $250 for donations they can't back up with receipts.
c) Yes. The entertainment part of such events is deductible. It's for charity, after all.
Answer: a. Moreover, if they received a tangible benefit, such as concert tickets, in exchange for any donation of more than $75, the charity must provide them with a written statement showing the benefit's value.
10 When they sold their old house in May 1999, the Shields made a $50,000 profit. How can they avoid paying tax on it?
a) They can't. Tax is due on their tax return for 1999.
b) They can't. But by rolling over those gains into the cost of a more expensive house, they've deferred the tax bill until they sell the new home.
c) No tax is due.
Answer: c. As long as they've owned the home for five years and lived in it for two of those years, the couple can exclude a gain of up to $500,000.
. Our tax quiz: And the winner is....