Investment and Other Income - See Special Enrollment Exam

1. What is the correct total federal income tax on the qualified dividends for 2025, including any net investment income tax?
   Answer: $9,210, because the dividends are taxed at the 15% capital gain rate and the 3.8% net investment income tax applies to $45,000 of the dividends. Governing authority: IRC § 1(h); IRC § 1411. Qualified dividends are taxed at the 0%, 15%, or 20% capital gain rates; for 2025 a single taxpayer reaches the 15% rate when taxable income exceeds $48,350, and the 20% rate does not start until taxable income exceeds $533,400. Taxable income is $195,000 + $50,000 − $15,750 = $229,250, so the entire $50,000 of dividends is taxed at 15%: $7,500. The net investment income tax is 3.8% of the lesser of net investment income ($50,000) or MAGI over the $200,000 single threshold ($245,000 − $200,000 = $45,000): $1,710. The total is $9,210. Choice A omits the net investment income tax. Choice B applies the NIIT to all of the dividends instead of only the $45,000 that exceeds the threshold. Choice C uses the 20% rate, which requires taxable income over $533,400.
2. How much of the qualified dividends is taxed at the 0% capital gain rate?
   Answer: $400 IRC § 1(h) and § 1(h)(11). Qualified dividends are taxed at the same 0%, 15%, and 20% rates as net capital gain. For 2025, the 0% rate for a single taxpayer applies to taxable income up to $48,350, and the gain-type income is stacked on top of ordinary taxable income. The taxpayer's ordinary taxable income is $63,700 - $15,750 = $47,950. The $10,000 of qualified dividends brings taxable income to $57,950, but the 0% bracket is already filled through $47,950, leaving only $400 ($48,350 - $47,950) of the dividends taxed at 0%; the other $9,600 is taxed at 15%. Choice A would be correct only if ordinary taxable income already equaled or exceeded $48,350. Choice B ignores the ordinary income that fills the 0% bracket. Choice D states the amount taxed at 15%, not 0%.
3. A single taxpayer's 2025 taxable income was $52,250. It consisted of wages and a $6,000 qualified dividend from a domestic corporation, and the dividend was the only item taxed at capital gain rates. What amount of the dividend is taxed at the 0% capital gain rate?
   Answer: $2,100 Under IRC §1(h)(1), qualified dividends are taxed using the capital gain rates. The taxpayer's ordinary taxable income is $46,250 ($52,250 − $6,000). For 2025, the single 0% rate bracket ends at $48,350, so the ordinary income portion of taxable income leaves only $2,100 of the 0% bracket for the qualified dividend ($48,350 − $46,250); the remaining $3,900 is taxed at 15% because taxable income is below the 15% ceiling. Choice A ($0) treats the total taxable income of $52,250 as already exceeding the 0% ceiling, without recognizing that ordinary income filled only $46,250 of that ceiling. Choice C ($3,900) is the portion taxed at 15%, not at 0%. Choice D ($6,000) applies the 0% rate to the entire dividend, ignoring that ordinary income occupies the lower part of the 0% bracket before the dividend is measured.
4. What amount of canceled debt must she include in gross income for 2025?
   Answer: $4,000 IRC § 61(a)(12) and § 108(a)(1)(B); see § 108(d)(3). Cancellation of debt is gross income unless an exclusion applies. A taxpayer who is insolvent immediately before the discharge excludes the discharged debt only up to the amount of insolvency, which is the excess of liabilities over the fair market value of assets. Here the taxpayer was insolvent by $48,000 - $40,000 = $8,000, so $8,000 of the $12,000 discharge is excluded and $4,000 is included; Choice B is correct. Choice A would be correct on these facts only if the amount of insolvency were at least $12,000. Choice C states the excluded portion, not the includible portion. Choice D ignores the insolvency exclusion.
5. On November 3, 2025, a taxpayer bought 200 shares of Acme, Inc. common stock for $50 per share. On December 18, 2025, he sold all 200 shares for $40 per share. On December 27, 2025, he bought 100 shares of Acme common stock for $45 per share and still held those shares at the end of the year. What is the adjusted basis of the 100 shares purchased on December 27?
   Answer: $5,500 IRC §1091(a) disallows a loss on a sale of stock to the extent substantially identical stock is acquired within 30 days before or after the sale, and IRC §1091(d) adds the disallowed loss to the basis of the replacement stock. The December 18 sale realized a $2,000 loss. The December 27 purchase replaced 100 of the 200 shares sold, so only $1,000 of the loss is disallowed. The replacement shares' basis is $4,500 cost ($45 × 100) plus $1,000 disallowed loss, or $5,500. Choice A ($4,500) ignores the wash sale adjustment and uses only the replacement cost. Choice B ($5,000) uses the $50-per-share basis of the old stock as the basis of the replacement shares, omitting the §1091(d) basis adjustment. Choice D ($6,500) adds the entire $2,000 realized loss to the replacement cost, ignoring that only 100 of the 200 shares sold were replaced.
6. What is the recognized loss on the December 5 sale and the basis of the 50 shares purchased on November 18?
   Answer: $250 recognized loss; basis $2,500 IRC § 1091(a) and (d). The wash-sale rule disallows a loss on a sale of stock when substantially identical stock was acquired within the 61-day period beginning 30 days before the sale and ending 30 days after it. If fewer shares are acquired than sold, the disallowed loss is limited to the number of replacement shares acquired. The taxpayer acquired 50 shares within the 30-day pre-sale period, so the loss on only 50 of the 100 shares sold is disallowed. The realized loss is 100 × ($40 - $35) = $500; $250 is disallowed and $250 is recognized. The basis of the 50 replacement shares is their $2,250 cost plus the $250 disallowed loss, or $2,500. Choice B ignores the wash-sale rule and recognizes the full $500 loss. Choice C disallows the entire $500 loss and increases basis by $500, but only $250 was disallowed because only 50 replacement shares were acquired. Choice D computes the correct recognized loss but fails to add the disallowed loss to the replacement shares' basis.
7. What amount must the taxpayer include in gross income as a dividend?
   Answer: $1,500, because an option to receive cash makes the stock distribution taxable as a property distribution IRC § 305(a) and (b)(1); § 301. A corporation's distribution of its own stock is generally not gross income. However, if any shareholder may elect to receive cash or other property instead of the stock, the stock distribution is treated as a distribution of property to which § 301 applies. Choice C is therefore correct. Because R Corporation had sufficient earnings and profits, the $1,500 fair market value of the stock received is taxable as a dividend. Choice A correctly states the general rule but is not the result here because the § 305(b)(1) exception applies. Choice B is wrong because the exception applies regardless of whether this particular taxpayer elected cash; the right of any shareholder to elect cash is enough. Choice D is wrong because many stock dividends are not taxable; a determinable fair market value alone does not make the distribution taxable.
8. Which of the following correctly describes the federal income tax treatment of the $1,000 difference between the purchase price and the face amount?
   Answer: $1,000 ordinary interest income, recognized in 2025 when the bond was redeemed, in addition to the $400 stated interest. Governing authority: IRC § 1276(a); IRC § 1278(a)(2)(C). Because the bond was issued at par and purchased later for less than face, the $1,000 difference is market discount, not original issue discount. On disposition of a market discount bond, gain is ordinary income to the extent of the accrued market discount; redemption at maturity is a disposition. Here the full $1,000 discount has accrued and is taxable as ordinary interest income in 2025. The discount is far above the de minimis threshold of 0.25% of the redemption price times the remaining years to maturity, so the exception does not apply. Choices A and C treat the amount as capital gain, but IRC § 1276 overrides capital gain treatment for accrued market discount on disposition. Choice D inverts the rule: the election under IRC § 1278(b) is to include the discount in income annually as it accrues; the election is not a precondition for ordinary treatment of the gain at disposition.
9. Which of the following is the correct treatment of the foreclosure on the taxpayer's 2025 federal income tax return?
   Answer: $15,000 of cancellation of debt income and a $60,000 capital loss on the land, with the loss subject to the annual capital loss limitation. Governing authority: IRC § 61(a)(12); IRC § 108(a)(1)(B); IRC § 1001; Treas. Reg. § 1.1001-2. When a recourse loan is foreclosed and the lender forgives the debt that exceeds the property's fair market value, the property is treated as sold for its fair market value, and the forgiven excess is cancellation of debt (COD) income. Here, the deemed sale price is $160,000, producing a $60,000 capital loss ($220,000 basis less $160,000), and the discharged debt is $40,000 ($200,000 less $160,000). COD income is excluded only to the extent the taxpayer was insolvent immediately before the discharge. Because the discharge occurred as part of the foreclosure, the insolvency test uses the facts given immediately before the foreclosure: liabilities of $300,000 exceed assets of $275,000 by $25,000, so $25,000 is excluded and $15,000 is taxable. Choice C correctly combines these results with the $60,000 capital loss, subject to the annual capital loss limitation and carryover. Choice A ignores the deemed sale and the insolvency exclusion. Choice B ignores the insolvency exclusion, which does apply to debt discharged in a foreclosure. Choice D applies the nonrecourse rule—treating the full debt as the amount realized—even though the loan is recourse. If COD income is excluded under IRC § 108, the taxpayer must reduce certain tax attributes under IRC § 108(b).
10. Which of the following correctly reflects the treatment of the gambling winnings and losses on her 2025 federal income tax return?
    Answer: Report the $15,000 winnings as other income and claim the standard deduction, so the gambling losses provide no deduction for 2025. Governing authority: IRC § 61(a); IRC § 165(d). Gambling winnings are gross income and are reported in full as other income; gambling losses are deductible only as an itemized deduction and only to the extent of gambling winnings. The taxpayer's losses would be limited to $15,000, but her only itemized deduction would be $15,000—less than the 2025 standard deduction of $15,750 for a single taxpayer—so she claims the standard deduction and receives no tax benefit from the losses. Choice B correctly states the winnings limit but fails to compare itemized deductions with the standard deduction. Choice C disregards the winnings limit. Choice D improperly nets the losses against the winnings in computing gross income; the losses cannot offset the winnings unless the taxpayer itemizes.
11. What amount of interest income must the taxpayer report for 2025, and what is her basis in the bond on December 31, 2025?
    Answer: $250; basis $10,250 IRC § 1272(a)(1) and (d)(2). Original issue discount on a corporate debt instrument is includible in gross income as it accrues under the constant yield method, even if the taxpayer receives no cash. The OID is reported as interest income, and the holder's basis is increased by the amount of OID included. The taxpayer therefore reports $250 and her basis becomes $10,000 + $250 = $10,250. Choice A ignores the annual OID inclusion rule. Choice C includes the income but does not increase basis. Choice B uses a straight-line allocation of the total $2,800 OID over the bond's term, not the constant-yield accrual stated in the facts.
12. In 2025, a taxpayer received or accrued the following items: $2,400 interest on a corporate bond; $700 original issue discount on a corporate zero-coupon bond purchased at original issue; $1,100 interest from redeeming U.S. Series EE savings bonds; $250 interest on a bank checking account; $1,800 interest on a municipal general obligation bond; $500 exempt-interest dividend from a municipal bond mutual fund; and $300 interest credited to her traditional IRA. What amount is taxable as interest income on her federal income tax return?
    Answer: $4,450 IRC §61(a)(4) requires interest income to be included unless specifically excluded, and IRC §1272(a)(1) requires original issue discount to be included as it accrues even though no cash was received. The taxable amount is $2,400 corporate interest + $700 OID + $1,100 Series EE bond interest + $250 bank interest = $4,450. Choice A ($3,750) omits the $700 OID, treating the zero-coupon bond as creating no current income because no cash was paid. Choice C ($4,750) adds the $300 interest credited to the traditional IRA; earnings inside an IRA are not currently taxable under IRC §408(e)(1). Choice D ($6,250) adds the $1,800 municipal bond interest, which is excludable under IRC §103(a), and the exempt-interest dividend is likewise not taxable interest income.
13. How much of the $12,000 of annuity payments received in 2025 is taxable?
    Answer: All $12,000, because the taxpayer's entire $100,000 investment had been fully recovered before 2025. IRC § 72(b)(2). For an annuity starting date after December 31, 1986, the total amount excluded under the exclusion ratio may not exceed the investment in the contract. The taxpayer excluded $500 of each $1,000 payment, so his $100,000 investment was fully recovered after 200 monthly payments, well before 2025. Every payment received after that is fully taxable, so all $12,000 received in 2025 is includible. Choice B is correct. Choice A applies the rule for annuity starting dates before 1987, under which the exclusion ratio continued for life. Choice C ties the exclusion to the guarantee period, which sets a minimum number of payments but does not end the exclusion. Choice D invents a recomputation of the exclusion ratio when the annuitant outlives the expected return.
14. What is the taxpayer's adjusted basis in the 60 shares purchased on June 30, 2025?
    Answer: $3,000, the $2,400 purchase price plus the $600 loss disallowed on the 60 shares reacquired within the 30-day period. Governing authority: IRC § 1091(a); Treas. Reg. § 1.1091-1. A loss on a sale of stock is disallowed to the extent the taxpayer acquires substantially identical stock within 30 days before or after the sale. The taxpayer sold 100 shares at a $1,000 loss and reacquired 60 shares within the period, so 60% of the loss ($600) is disallowed; the remaining $400 loss is deductible. The disallowed loss is added to the basis of the replacement shares: $2,400 + $600 = $3,000. Choice A ignores the wash sale rule entirely. Choice C disallows the entire $1,000 loss even though only 60 of the 100 shares were replaced. Choice D adjusts the basis in the wrong direction: the disallowed loss increases, rather than decreases, the basis of the replacement shares.
15. What amount of the $2,000 of savings bond interest must the taxpayer include in gross income for 2025?
    Answer: $1,300 IRC § 135. Choice D is correct. The bonds are qualified U.S. savings bonds because they were issued after 1989 to an individual who had attained age 24 before the issue date, and the redemption proceeds were used to pay qualified higher education expenses for the taxpayer's dependent. Qualified expenses are reduced by tax-free scholarships: $12,000 - $5,000 = $7,000. Because the $10,000 redemption proceeds exceed those expenses, IRC § 135(b)(1) limits the pre-phase-out exclusion to $2,000 × ($7,000 / $10,000) = $1,400. For 2025, the exclusion phase-out range for a single taxpayer is $99,500-$114,500 of modified AGI. At $107,000, the reduction is ($107,000 - $99,500) / ($114,500 - $99,500) = 50%, so the excludable amount is $1,400 × 50% = $700. Therefore, the taxpayer must include $2,000 - $700 = $1,300 in gross income. Choice A ($600) is the result if the expense-proceeds limitation is applied but the modified-AGI phase-out is ignored. Choice B ($1,000) is the result if the 50% phase-out is applied to the full $2,000 of interest, ignoring the scholarship reduction and the expense-proceeds limitation. Choice C ($2,000) would deny the exclusion entirely; the ownership and use requirements are met, and the exclusion is only partially phased out at this income level.

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