Unit 3: Federal Taxation of Individuals

• Topic 01

  Gross Income

  17 questions
• Topic 02

  Adjusted Gross Income (AGI)

  29 questions
• Topic 03

  Itemised Deductions vs. Standard Deduction

  15 questions
• Topic 04

  Tax Credits

  17 questions
• Topic 05

  Alternative Minimum Tax (AMT)

  27 questions
• Topic 06

  Tax on Net Investment Income and Additional Medicare Tax

  45 questions
• Topic 07

  Retirement Plans

  15 questions
• Topic 08

  Self-Employment Income and Tax

  15 questions
• Topic 09

  Filing Status and Dependency

  28 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. For Head of Household purposes, can a qualifying parent who lives in a separate nursing home serve as the qualifying person, even though the parent does not live in the taxpayer's home?

   • A
     No — only qualifying children (not qualifying relatives) can serve as qualifying persons for HOH.
   • B
     Yes — the parent qualifies automatically as long as the taxpayer is the primary caregiver.
   • C
     Yes — but only if the parent is also claimed as a dependent on the taxpayer's return.
   • D
     Yes — a parent qualifies as a qualifying person for HOH even if the parent does not live with the taxpayer, provided the taxpayer pays more than half the cost of maintaining the parent's separate home.
     Correct answer
   Explanation

   IRC §2(b)(1)(B) creates a special HOH rule for taxpayers whose qualifying person is their parent. Unlike other qualifying persons who must live in the taxpayer's home, a parent need not live with the taxpayer. Instead, the taxpayer must pay more than half the cost of maintaining the parent's principal place of abode (which can be a nursing home or separate residence). The taxpayer must still be unmarried and satisfy the other HOH tests. This is the only qualifying person for HOH purposes who does not have to live in the taxpayer's home.

2. A divorced taxpayer (Parent A) has AGI of $80,000 and the child lives with her 200 nights per year. The other parent (Parent B) has AGI of $120,000 and the child lives with Parent B 165 nights per year. Parent A does not claim the child; Parent B claims the child without a Form 8332. Which of the following correctly describes the tax result?

   • A
     Parent B may claim the child under the multiple support agreement rules.
   • B
     Parent B may claim the child because 165 nights is still more than 90 days.
   • C
     Parent B may not claim the child without a Form 8332 from Parent A, because Parent A (the custodial parent with the greater number of nights) has priority under the tie-breaker rules.
     Correct answer
   • D
     Parent B may claim the child because Parent B has higher AGI.
   Explanation

   Under the tie-breaker rules, the parent with whom the child lived the longer period (200 nights > 165 nights) — Parent A — is the custodial parent and has priority. Parent B can only claim the child if Parent A releases the dependency by signing Form 8332. Parent A's decision not to claim the child does not automatically transfer the dependency to Parent B; formal release via Form 8332 is required. AGI is the tiebreaker only when the nights are equal, which is not the case here.

3. Is tax-exempt municipal bond interest included in net investment income (NII) for purposes of the NIIT?

   • A
     Yes. Tax-exempt interest reduces the NIIT threshold, effectively increasing the amount of NII subject to tax.
   • B
     No. Municipal bond interest is excluded from gross income under §103 and is also excluded from NII.
     Correct answer
   • C
     Yes. Tax-exempt interest is included in NII because it represents a return on a passive investment.
   • D
     No, but only for municipal bonds issued after 2012, when the NIIT first took effect.
   Explanation

   Under IRC §1411(c)(1), NII is defined by reference to income and deductions 'taken into account in computing taxable income.' Municipal bond interest excluded under §103 is not taken into account in computing taxable income, so it is also excluded from NII. Option D describes a partially correct statement: municipal bond interest IS included in MAGI for the Social Security provisional income calculation, but for NIIT purposes, the MAGI definition in §1411(d) uses regular MAGI (AGI with certain add-backs, as defined in the regulations), and tax-exempt interest is generally excluded from NIIT MAGI as well — unlike the Social Security calculation where it is added back. Option B incorrectly includes tax-exempt interest in NII. Option C fabricates a dollar threshold. Option E confuses AMT treatment of private activity bond interest (which can be an AMT preference item) with NIIT treatment of municipal bond interest generally. Option F is partially correct (tax-exempt interest is excluded from MAGI for NIIT, unlike for Social Security) but misdescribes the rule.