REG · Federal Taxation of Individuals · 6 practice questions
CPA REG Deduction Timing, Eligibility, and Credit Value
Timing and eligibility determine whether a tax benefit is allowed now; its tax effect determines what it is worth. Below, sort independent Reed examples by the test they trigger before using the free practice questions.
Try one first
Hint
Recompute Year 1 as if the refund had reduced the state tax paid before the return was filed, then ask how much of Reed's federal deduction benefit would actually have changed.
Answer B. Under the tax benefit rule, include only the portion of a recovery that produced a federal tax benefit in the prior year. Recompute Year 1 with the state tax reduced by $4,000: state tax would have been $2,000, so SALT would be $9,000 (2,000 + 7,000) instead of the $10,000 deduction actually claimed. Itemized deductions would drop from $15,000 to $14,000, and because the standard deduction was $13,000, only $1,000 of the refund produced a federal tax benefit and must be included in Year 2 gross income.
Why not A: Tempting because of the SALT cap, but incorrect: after reducing the state tax by $4,000 the SALT deduction would fall to $9,000, lowering Year 1 itemized deductions so that $1,000 of the refund produced a federal tax benefit and is taxable in Year 2.
Why not C: Plausible because original itemized deductions exceeded the standard deduction by $2,000, but the refund only reduces the prior-year excess by $1,000 (itemized would fall from $15,000 to $14,000), so only $1,000 is taxable.
Why not D: Incorrect: not all recoveries are taxable, only the portion that produced a prior-year federal tax benefit. Here the recomputation shows only $1,000 produced a benefit.
Sort it
Does the fact decide when an otherwise deductible payment is deducted?
Does the fact decide whether the taxpayer qualifies for the deduction?
Does the fact decide how much tax changes or how much recovered tax enters income?
| Item | Goes to |
|---|---|
| Cash-basis Reed charges an otherwise deductible charitable contribution to a personal credit card on December 30 and pays the card bill in January. | TimingThe contribution is treated as paid when charged, so it belongs in the December tax year. |
| Reed has family HDHP coverage, no Medicare, and cannot be claimed as a dependent. The only other coverage is a dental-and-vision-only FSA. | EligibilityThe limited-purpose FSA does not disqualify Reed. A personal HSA contribution within the contribution limit is deductible. |
| Reed can use either a $2,000 deduction or a $2,000 nonrefundable credit at a 22% marginal rate, with sufficient tax liability and no other limits. | Tax effectThe deduction saves $440: $2,000 × 22%. The credit saves $2,000. |
| Self-employed Reed pays $900 monthly health insurance premiums. A spouse's employer-subsidized family plan first becomes available to Reed July 1, but Reed declines enrollment. All other deduction requirements are met. | EligibilityOnly January through June qualify: 6 × $900 = $5,400. Eligibility blocks July through December even without enrollment. |
| Reed pays $6,000 of points from personal funds on a 15-year mortgage refinance secured by Reed's main home. One-quarter of the proceeds funds an addition. Qualified residence interest limits and all other current-deduction requirements are met. | TimingThe improvement portion, $6,000 × 25% = $1,500, is deductible currently. Amortize the remaining $4,500 over 15 years. |
| In Year 1, Reed paid $6,000 state income tax and $7,000 property tax. The stated SALT cap was $10,000; other itemized deductions were $5,000 and the standard deduction was $13,000. Reed itemized, had no AMT, and received a $4,000 state refund in Year 2. | Tax effectInclude $1,000 in Year 2. Recomputed itemized deductions fall from $15,000 to $14,000, still above the $13,000 standard deduction. |
| Reed is single, cannot be claimed as a dependent, and pays interest on Reed's own qualified student loan. All income and dollar limits are satisfied. | EligibilityReed meets the legal-obligation, payment, filing-status, and dependency tests for the student loan interest deduction. |
| Cash-basis Reed mails a check for otherwise deductible property taxes on December 31. The check arrives in January and is honored when first presented. | TimingThe payment belongs in the year mailed, not the year the tax collector receives the check. |
| Reed has HDHP coverage, but a spouse's general-purpose health FSA can reimburse Reed's medical expenses. | EligibilityThe general-purpose FSA is disqualifying other coverage for HSA purposes, even if Reed never requests reimbursement. |
| Reed has $850 of federal income tax liability before a $1,200 nonrefundable credit. No carryforward applies. | Tax effectThe credit eliminates the $850 liability. The unused $350 creates neither a refund nor a carryforward. |
| Cash-basis Reed signs a charitable pledge in December but pays the contribution in January. | TimingA promise is not payment. The otherwise deductible contribution belongs in the January tax year. |
| Reed pays interest on an adult daughter's qualified student loan but is not a borrower, co-signer, or otherwise legally obligated on it. | EligibilityPayment alone is insufficient. Reed cannot claim the student loan interest deduction without a legal obligation on the loan. |
| Reed has HDHP coverage but is enrolled in Medicare Part A for the entire year. | EligibilityMedicare enrollment disqualifies Reed from making a deductible HSA contribution for that year. |
| Reed has HDHP coverage, no Medicare, and no other coverage, but another taxpayer can claim Reed as a dependent. | EligibilityBeing claimable as a dependent prevents HSA eligibility, even if nobody actually claims Reed. |
Key points
- Remember: Separate when a benefit applies from whether it is allowed and how much tax it saves.
- An above-the-line deduction reduces AGI; it is not a dollar-for-dollar tax credit.
- Use the problem's stated SALT limit and standard deduction when testing a state tax refund.
- An unused nonrefundable credit carries forward only if that credit's rules allow it.
How the exam traps you
- Treating unused nonrefundable credit as a refund. Stop at zero liability; apply a carryforward only when the credit allows one.
- Taxing the entire state refund merely because Reed itemized. Recompute the prior deduction after the refund, using the stated SALT cap and standard deduction.
- Using actual enrollment to test the self-employed health insurance deduction. Check monthly eligibility for either spouse's employer-subsidized plan, even if Reed declines coverage.
Question 2
Hint
For HSA eligibility, do not stop after confirming HDHP coverage. Also check for other health coverage, Medicare enrollment, and whether the person can be claimed as a dependent.
Answer D. To be an eligible individual for HSA purposes, a taxpayer must be covered by an HDHP, have no disqualifying other health coverage, not be enrolled in Medicare, and not be claimable as another person's dependent. A limited-purpose FSA that is restricted to dental and vision expenses is not treated as disqualifying other coverage. Because the taxpayer in option C meets the HDHP requirement and lacks Medicare enrollment, dependency status, and any general-purpose FSA coverage, that taxpayer may make and deduct an HSA contribution for Year 1.
Why not A: This is tempting because the taxpayer has self-only HDHP coverage for the full year. However, access to a spouse's general-purpose health FSA that can reimburse the taxpayer's medical expenses is disqualifying other coverage for HSA eligibility, so the taxpayer is not an eligible individual.
Why not B: This is tempting because the taxpayer also has full-year HDHP coverage, but enrollment in Medicare (including Part A) makes a taxpayer ineligible to contribute to an HSA for the period of Medicare enrollment. Because this taxpayer is enrolled in Medicare for all of Year 1, they cannot deduct HSA contributions for Year 1.
Why not C: This choice is tempting because it satisfies the HDHP and Medicare requirements, but being claimable as another taxpayer's dependent disqualifies a person from being an eligible individual for HSA purposes. Therefore this taxpayer cannot deduct an HSA contribution.
Question 3
Hint
Focus on whether the rule turns on actual enrollment or eligibility, and then apply that rule month by month.
Answer A. The self-employed health insurance deduction is disallowed for any month the taxpayer is eligible to participate in a health plan subsidized by the employer of the taxpayer or the taxpayer's spouse. Jordan was not eligible through June 30, so the six months of premiums (6 × $900 = $5,400) are deductible for AGI. Beginning July 1 the spouse became eligible for family coverage, so Jordan was eligible to participate and those months are not deductible even though the spouse elected employee-only coverage.
Why not B: This distractor relies on actual enrollment rather than eligibility. The governing test is whether the taxpayer was eligible to participate in a subsidized employer plan (of the taxpayer or spouse) in a given month, not whether the taxpayer was actually enrolled. Therefore the July-December months are disqualified.
Why not C: This choice recognizes the midyear change but reverses the correct application. The deduction is allowed for months before the spouse's subsidized family plan became available (January-June), not for the months after.
Why not D: This is an annual 'all-or-nothing' misreading. The limitation is applied on a month-by-month basis, so premiums paid for months when the taxpayer was not eligible for the spouse's plan remain deductible.
Question 4
Hint
Check the basic eligibility gates for this deduction before thinking about income limits.
Answer C. A taxpayer may deduct student loan interest only if the taxpayer is legally obligated on the qualified education loan, actually paid the interest, is not married filing separately, and cannot be claimed as a dependent by another taxpayer. Avery meets those requirements here. Therefore, Avery is the only taxpayer who may claim the deduction (subject to the general annual dollar limit).
Why not A: This is tempting because Casey paid interest on his own qualified loan, but married filing separately is a disqualifying filing status for the student loan interest deduction, so Casey cannot claim it even if other requirements are met.
Why not B: This is tempting because Blake actually paid interest on a qualified loan, but the deduction is limited to interest on a loan for which the taxpayer is legally obligated (borrower, co-signer, or otherwise legally liable). Since Blake is not legally obligated, he cannot deduct the interest.
Why not D: This is tempting since Devon is the borrower and paid the interest, but a taxpayer who can be claimed as a dependent by another taxpayer cannot claim the student loan interest deduction, so Devon is disqualified.
Question 5
| Item | Amount |
|---|---|
| On December 30, Year 1, Rae charged a cash contribution to a qualified charity on a personal credit card. Rae paid the credit card bill in January, Year 2 | $1,600 |
| On December 31, Year 1, Rae mailed a check to the county tax collector for deductible real property taxes. The county received the check in January, Year 2 | $1,200 |
| On December 20, Year 1, Rae signed a written pledge to contribute to a qualified charity and paid it on January 10, Year 2 | $2,000 |
| Rae received deductible medical services in December, Year 1, but did not pay the bill until January, Year 2 | $900 |
Hint
Focus on when a cash-basis taxpayer is treated as having actually paid each item. A year-end promise, a mailed check, and a credit-card charge do not all trigger deductions at the same time.
Answer A. Under the cash method, amounts are deductible when paid. A charitable contribution charged to a credit card is treated as paid when charged, and a check mailed before year-end is treated as paid in the year mailed if the check is honored when first presented. The written pledge and the medical bill were not actually paid until Year 2, so only $1,600 + $1,200 = $2,800 is deductible in Year 1.
Why not B: This choice includes only the credit-card charitable contribution and ignores the mailed real property tax check, which is treated as paid in Year 1 when mailed (given that the check is honored upon presentation).
Why not C: This total incorrectly adds the $900 medical bill. For a cash-basis taxpayer, medical expenses are deductible when actually paid, and the medical bill was paid in January Year 2, not Year 1.
Why not D: This choice treats the $2,000 written pledge as deductible in Year 1. Under the cash method, a written pledge is not deductible until the contribution is actually paid (here, January Year 2).
Question 6
Hint
Ask which item changes taxable income and which item changes the tax after it has been calculated.
Answer D. A deduction reduces taxable income rather than tax liability directly. At a 22% marginal rate, a $2,000 deduction lowers tax by $2,000 × 22% = $440. A $2,000 nonrefundable tax credit reduces tax liability dollar for dollar, so it lowers tax by the full $2,000 provided the taxpayer has enough tax to absorb it.
Why not A: Tempting because both benefits list $2,000, but a deduction is applied to taxable income and must be multiplied by the marginal rate; only a credit reduces tax dollar for dollar.
Why not B: This applies the marginal tax rate to both items incorrectly. Only the deduction's effect is scaled by the marginal rate; a credit is not multiplied by the rate because it reduces tax dollar for dollar.
Why not C: This reverses the correct treatments. Deductions affect taxable income (so their tax effect is the deduction times the marginal rate), whereas tax credits directly offset tax liability.
Common questions
How much does a tax credit save compared with a deduction?
A deduction saves the deduction amount multiplied by the marginal tax rate. A credit saves tax dollar for dollar, but a nonrefundable credit cannot reduce liability below zero.
Is a state income tax refund taxable if the SALT deduction was capped?
The cap does not automatically make the refund tax-free. Include only the refund portion that produced a prior-year federal tax benefit, considering both the SALT cap and the standard deduction.
Who qualifies for the student loan interest deduction?
The taxpayer must pay interest on a qualified loan the taxpayer legally owes, cannot be claimable as a dependent, and cannot file married filing separately. Income limits also apply.
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