Tax IQ Quiz: The Answers

The IRS will be pleased to know that most <I>TSC</I> readers aced this quiz.
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Uncle Sam doesn't have to worry about

TSC

readers. They know their tax law!

More than 1,700 readers took the

TSC

Tax IQ quiz, and a majority answered each of the dozen questions correctly.

As promised, here are the correct responses to each question. If you haven't yet taken the quiz, why not try it

now? Then you can check your answers below with the rest of us.

Thanks to David Bergmann, a certified financial planner in Marina Del Ray, Calif., and member of the editorial board for the

Institute of Certified Financial Planners

, for helping with the responses.

If you have any questions on any tax issue, send them to

taxforum@thestreet.com. And don't forget to include your full name.

Question: What's the last day you can make a deductible contribution to your individual retirement account and have it apply to your 1998 tax year?

Answer: C. April 15, 1999.

The vast majority of you know this one. It does not matter if you put your tax return on extension until Aug. 15. Your IRA contribution still must be in by April 15.

Question: Social Security benefits are not taxable, true or false?

Answer: False.

Again, most of you answered this correctly. Up to 85% of your Social Security benefits may be taxable by the federal government if your modified adjusted gross income is above $25,000 for a single person or $32,000 for joint filers.

There's a worksheet on page 3 of

Publication 915 --

Social Security and Equivalent Railroad Retirement Benefits

to help you determine how much of your benefits will be taxable.

Some states also will tax Social Security benefits, so check out your state's instructions as well.

Question: Medical expenses must exceed what portion of your adjusted gross income to be deductible?

Answer: B. 7.5%.

This question seemed to confuse many of you. To start, the only medical and dental expenses that can be considered here are the ones that are

not

paid by your insurance.

In addition, you can only deduct your unreimbursed medical and dental expenses that

exceed

7.5% of your adjusted gross income. Let's say your AGI is $100,000 and your unreimbursed medical expenses are $5,000. Calculating 7.5% of your AGI will give you $7,500. Since your expenses do not exceed this amount, nothing is deductible. If your unreimbursed medical and dental expenses were $10,000, you'd get a medical deduction on your Schedule A for $2,500.

See

Publication 502 --

Medical and Dental Expenses

for a listing of expenses that would qualify. Keep in mind, if you do not itemize your deductions on

Schedule A --

Itemized Deductions

, you do not have to bother with this.

Question: Earnings from tax-free municipal bonds are never subject to federal income tax, true or false?

Answer: False.

The beauty of a municipal bond is that any interest generated is not subject to federal income tax. Although if you fall into the realm of the alternative minimum tax, that bond interest will be taxable. (For more on AMT, check out this previous

story from the

TSC

series, Buying Bonds: A Primer.)

But what if the face value of the bond increases? When you sell the bond you will, in turn, receive earnings -- just as if your stock value increased. Those earnings will be subject to capital gains.

Question: Federal unemployment income is not subject to federal tax, true or false?

Answer: False.

Three-quarters of you got this one right. If you received any unemployment compensation in 1998, it's all taxable. You should have gotten a

Form 1099-G --

Certain Government Payments

showing the amount of unemployment compensation you received. That amount is reported on line 19, Unemployment Compensation, on your

Form 1040.

Question: It is better to take a $100 tax credit than a $100 tax deduction, true or false?

Answer: True.

Another easy one for

TSC

readers. A credit is always better because the amount is subtracted from your total tax bill, dollar for dollar. So a $100 tax credit will save you $100 in taxes.

On the other hand, a tax deduction is taken

before

your tax bill is calculated. So, a person in the 28% tax bracket only would save $28 on a $100 tax deduction.

Question: If you are 65 years old, up to how much of your long-term-care insurance premiums can be treated as medical expenses?

Answer: D. $2,050.

This question stumped about half of the crowd, and rightfully so. It was tough.

Qualified long-term-care insurance is an insurance contract that provides the necessary services for diagnostic, preventive, therapeutic, curing, treating, mitigating and rehabilitative services, and maintenance or personal-care services that are required by a chronically ill individual, according to the

Research Institute of America

.

The amount that can be treated as an annual medical expense varies with your age and in 1998 ranges from $210 if you're under 40 to $2,570 if you're over 70. Deductions are adjusted each year for inflation. The range for 1999 will be $210 to $2,660.

Question: You cannot take the new Hope Scholarship tax credit if your modified adjusted gross income exceeds $100,000, true or false?

Answer: True.

The credit is available to single taxpayers with adjusted gross incomes up to $40,000 ($80,000 if married and filing jointly). The credit is phased out for the single taxpayers with incomes between $40,000 and $50,000 ($80,000 to $100,000 if married and filing jointly). See our previous

story for more information on this credit.

Question: The interest paid on which of the following types of personal loans is usually tax deductible?

Answer: A. Home Equity.

Congratulations! Practically, everyone got this correct.

Generally, you can deduct the interest on up to $100,000 of home equity loans secured by your home. So here's a tip: Use your home equity loan to pay off your credit card and car debts.

Question: Professional tax preparation and tax planning fees are not tax deductible, true or false?

Answer: False.

You bet they are. And most of you knew this, so just don't forget about them when you prepare your return. You must be itemizing your expenses to claim this deduction. Then your tax prep and planning fees can be deducted as a miscellaneous deduction as long as your total miscellaneous deductions exceed 2% of your adjusted gross income.

Question: The minimum age at which you must begin taxable withdrawals from an employer-sponsored retirement plan such as a 401(k) is:

Answer: D. 70 1/2 or when you retire, whichever is later.

If you have a 401(k) at work and continue to be employed until, say age 75, you would not have to start taking withdrawals from your 401(k) until that time. But for an IRA, you must begin withdrawals no later than age 70 1/2. It does not matter when you retire.

Remember, you always can start to withdraw from your retirement accounts at 59 1/2, penalty-free.

Question: The alternative minimum tax does not affect middle-income taxpayers, true or false?

Answer: False.

Although the AMT was designed to ensure that wealthier taxpayers don't escape paying income tax through heavy deductions, the AMT is catching more and more middle-income taxpayers because the deductions haven't been indexed for inflation.

TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.