IRS - Internal Revenue Service Certified Income and Assets Questions and Answers 1 — Questions and Answers
Question 1: Which of the following is generally considered taxable income by the IRS?
- A cash prize won in a contest (Correct answer)
- A gift from a family member
- Child support payments received
- Life insurance proceeds received due to the death of the insured
Correct answer: A cash prize won in a contest
The IRS considers prizes and awards to be taxable income. Gifts, child support, and most life insurance proceeds are typically not taxable to the recipient.
Question 2: A taxpayer purchases a rental property for $250,000. They pay $20,000 in closing costs, including legal fees and transfer taxes. What is the taxpayer's cost basis in the property?
- $250,000
- $230,000
- $270,000 (Correct answer)
- $20,000
Correct answer: $270,000
The cost basis of a property is generally its purchase price plus any costs associated with the purchase, such as closing costs, legal fees, and recording fees. Therefore, the taxpayer's basis is $250,000 + $20,000 = $270,000.
Question 3: A freelance graphic designer receives a check for a completed project on December 30th of the current tax year but does not deposit it until January 2nd of the following year. According to the doctrine of constructive receipt, in which year should the income be reported?
- The following year, when the check was deposited
- The income can be split between the two years
- The current tax year, when the check was received (Correct answer)
- The year the project was initially commissioned
Correct answer: The current tax year, when the check was received
Under the doctrine of constructive receipt, income is taxable in the year it is made available to the taxpayer without any substantial restrictions. Since the designer had control over the check on December 30th, the income must be reported in that tax year.
Question 4: Which of the following is NOT a capital asset according to the IRS?
- A personal residence
- Stocks and bonds held for investment
- Inventory of a business (Correct answer)
- A valuable painting owned by a collector
Correct answer: Inventory of a business
The IRS defines a capital asset as almost everything owned for personal or investment purposes. However, inventory held by a business for sale to customers is specifically excluded from this definition and is treated as ordinary business property.
Question 5: A taxpayer sells an investment property and has a capital gain. To be classified as a long-term capital gain, how long must the taxpayer have held the asset before selling it?
- Exactly one year
- More than one year (Correct answer)
- At least six months
- Less than one year
Correct answer: More than one year
To qualify for long-term capital gains tax rates, which are typically lower than short-term rates, a taxpayer must hold a capital asset for more than one year before its sale or disposition.
Question 6: A taxpayer receives a state tax refund for a year in which they took the standard deduction on their federal return. How is this state tax refund treated for federal income tax purposes?
- It is fully taxable as income.
- It is not taxable. (Correct answer)
- It is partially taxable based on the taxpayer's income level.
- It is treated as a long-term capital gain.
Correct answer: It is not taxable.
If a taxpayer claimed the standard deduction on their federal return in the year the state tax was paid, the state tax refund is not taxable. The 'tax benefit rule' states that a refund of a previously deducted expense is only taxable to the extent that the original deduction provided a tax benefit. Since no deduction was taken for state taxes, the refund is not considered income.
IRS - Internal Revenue Service Certified Income and Assets Questions and Answers 1
Which of the following is generally considered taxable income by the IRS?