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REG CPA Practice Questions: Tax-Exempt Interest and Gross Income
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May 3, 2024
In this video, we walk through 5 REG CPA exam practice questions on how to calculate the amount of tax-exempt interest that should be excluded from an individual's gross income. Important Links Link to the free study training webinar mentioned in the video: https://www.superfastcpa.com/strategic-study See the full post for this video: https://www.superfastcpa.com/reg-cpa-practice-questions-explained-calculate-tax-exempt-interest-excluded-from-gross-income/ See the other REG walkthrough videos here: https://www.superfastcpa.com/free-reg-cpa-practice-question-walkthroughs/ 00:00 Intro 00:42 Question 1: Tax Exempt Interest from Municipal Bonds 02:26 Question 2: Taxable Interest from a Savings Account 04:33 Question 3: U.S. Series EE Savings Bonds Tax Exempt Interest 08:00 Question 4: Tax Exempt Interest from an HSA 09:22 Question 5: Interest from a Tax Refund 10:24 Pillar Topics
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Hi. I'm Logan. Welcome to another reg walkthrough video. In today's video, we're going to be going
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over calculating tax-exempt interest excluded from gross income. Again, we're going to be doing it
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the Super Fast CPA way, where we jump straight into questions to learn the material. If you don't
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know much about our strategies, make sure you go to superfastcpa.com to watch our free one-hour
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webinar training, where we go over the six key ingredients to passing the CPA exam. Again
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it's free, it's only one hour long, it's well worth your time. If you like the idea of doing
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questions as your main learning material. You should check out our super fast CPA app where we have
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five question mini quizzes that you can do on the go to continually be practicing questions and
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material. With all that said, let's dive straight into some questions. All right, here's the first question
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An individual has received various types of interest income this year, $250 from a U.S. Treasury bond
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and $400 from a bond issued by the local city government. Based on tax law, which of the following
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amounts should be excluded from the individual's gross income. So just one thing I want to note there
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make sure you always pay attention to the wording of the question. A lot of questions might ask
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what should be included in the individual's gross income, but this question is asking what should
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be excluded. So just make sure you always pay attention to that. As far as knowing the answer
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if this is your first time looking at this or if you're struggling with this topic, then you probably
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don't know much about it. So what we typically do in these situations is just go straight into the
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answer to start learning the material. So let's go ahead. ahead and do that. All right, here's the answer. So $400 should be excluded from the individual's gross
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income. Let's learn why. Interest earned on local and state government bonds, often referred to as
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municipal bonds, is typically exempt from federal income tax. Therefore, the $400 of interest from the
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local city government is excluded from the individual's gross income. Interest earned from
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U.S. Treasury bonds is generally included in federal gross income, although it is often exempt from
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state and local taxes. Therefore, the $200 of interest on the U.S. Treasury bond is included
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in the individual's gross income. So it was asking what's excluded. So in this situation
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it's the $400 from the municipal bonds. So that's one key thing to learn from this. A lot of
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interest is taxable, but we're trying to learn more about what interest is tax exempt in this video
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So municipal bonds are tax exempt most of the time. And a municipal bond is something like it says
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here from a local or a state government, but not necessarily from the federal government
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All right, we learned one little piece there. Let's go ahead and go to the next question. All right, here's the next question. During the current tax year, Jordan received $1,200
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as a state tax refund from the prior year's state income tax overpayment. She also earned $600
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from a high yield savings account and $150 as a rebate from her energy provider for installing
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solar panels. Jordan did not itemize deductions in the prior year. What is the total amount of
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this income that Jordan must include in her federal gross income? So again, different there. It's
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asking what should be included. So take a second. read through the question, make sure you understand it. We're still trying to learn what is tax-exempt
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interest and what isn't. So if you don't know this, that's okay. Go ahead and take a second if you need to
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but let go ahead and go straight into the answer So should be included The earned from the savings account is taxable interest income Okay so your typical savings interest from your bank account does taxable income The rebate is considered a reduction of the cost
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of the solar panels and is not taxable income. Okay, so first off, we're talking about interest mainly
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in this video, but that's good information right there that a rebate is just a reduction in the cost
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of something. It's not necessarily income. Neither state nor federal tax refunds are considered income
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and are not included in the federal gross income. However, if Jordan itemized deductions in the prior year
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and claimed a deduction for state income taxes, then the state refund could be taxable
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All right, so we're not going to dive super deep into this in this video, but just know that specifically for state tax refunds
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and this doesn't necessarily have to do with interest, but this is good to know. State tax refunds are not taxable
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but they can be if you itemized deductions in the prior year
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Again, we're not going to dive super deep into why, but that's just a good rule to know that state and federal tax refunds are not considered income
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but state tax refunds can be taxable if you had itemized deductions in the prior tax year
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But as far as this question goes, it's just good to know that state tax refund, not taxable
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the high yield interest from your savings, again, that is taxable, and then the rebate isn't taxable either
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Let's go to the next question. Here's the next question. Lewis recently received a detailed summary of interest in
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income for the year. It included $450 from a certificate of deposit at his local bank, and $200 from
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US Series E savings bonds, which were redeemed to pay for his daughter's college tuition. Additionally
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he had a state tax refund of $800 due to an overpayment on his last year's taxes
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Considering that Lewis took the standard deduction on his federal tax return in the previous year
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what is the total amount of interest income he must report on his current year's federal income
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tax return? All right, so we've learned a lot already up to this point. First off, a certificate
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of deposit, that just sounds kind of like savings, like some kind of thing in your bank
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That's probably going to be taxable. We're not sure if savings bonds for education are going to be
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taxable or not taxable. But we did learn that state tax refunds are not taxable. And this doesn't
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mention that any interest was earned on that state tax refund. So we know that this is not going to be
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taxable. So what is the amount of interest income? First off, this isn't even interest income. So
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make sure you pay attention to things like that. What is the total amount of interest income he must
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report on his current year's federal income tax returns? So definitely this $450, but we don't know yet
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if the $200 from the U.S. series EE savings bonds are going to be taxable or not. So take a second
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read through the question, make sure you understand it, and come back and we'll learn a little bit more
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All right, here's the answer. $450 is going to be taxable as interest income. So let's learn more about
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that. $450 from the certificate of deposit is taxable interest income. We figured that. The $200 from
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the US Series E savings bonds interest is excluded from gross income because it was used for qualifying
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educational expenses and thus meets the requirements for the education tax exclusion. Okay, so right
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there if you see US Series E savings bonds interest in a question but it doesn mention that it was used for some kind of education expense like a qualifying education expense then it is taxable But in this case it mentioned that it was used for his daughter college tuition
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So we know that that is a qualifying education expense, and there is a tax rule that that can be excluded from
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taxable income. All right. And then the state tax refund, we knew that wasn't going to be taxable
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And she didn't itemize deductions, so still not taxable. Let's learn a little bit more about what
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U.S. Series E. savings bonds are. They are a type of U.S. government savings bond that is guaranteed
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to at least double in value over the original term of the bond, typically 20 years. They are a low-risk
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investment product that pays interest until they reach 30 years or are cashed in, whichever comes
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first. The interest earned is subject to federal income tax but is exempt from state and local
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taxes. For a series E.E bonds issued after 1989, the interest may be entirely or partially
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excluded from federal income tax when the bond owner pays qualified higher education expenses at an
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eligible institution. Okay, that's another thing to remember right there. It has to be a higher education
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expense, as in college or something like that. Probably wouldn't count if you took it out to pay for a
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high school sport or something like that. This tax benefit is subject to income limitations and
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other requirements. Okay, so that's one thing right there that you learned. Interest from savings bonds
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that are for educational expenses, it is not taxable if withdrawals from the savings bonds are for
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higher education expenses. All right, let's go to the next question. Melanie contributed to a health
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savings account, or HSA, to cover her qualifying medical expenses. Throughout the year, she made the
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maximum allowable contribution, and her HSA earned $600 in interest. During the same year, Melanie
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paid out $4,000 in qualified medical expenses from this HSA. No additional distributions were made
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How should Melanie report the interest earned on her HSA when filing her federal income tax return
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All right. So this is probably pretty similar to the qualifying educational expenses
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A good guess would be that this is tax-exempt interest. But when we're going through questions as our learning material, we're not worried about whether we know the answer or not
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We just want to get into the answers so that we can learn what we need to learn
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So let's go ahead and get into the answer. So like we were saying, we do not report the $600 as it is tax-exempt provided
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it is used for qualified medical expenses. Interest earned on the balance in an HSA is tax exempt as long as the funds are used for
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qualified medical expenses. Since Melanie used her HSA funds to pay for qualified medical expenses, the $600 interest earned
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in the HSA is not included in her taxable income. Okay, awesome. One note I want to make is I saw this frequently when I was working in taxes myself
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So this is definitely something that you want to pay attention to. As long as the distributions from the HSA are for qualified medical expenses, the HSA
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say interest is tax exempt. All right, let's go to the final question. Okay, here's the last
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question. Jonathan received a federal income tax refund of $2,000, which was due to excess withholding
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in the previous tax year. Additionally, the refund was delayed, and he received $150 as interest on the
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late refund payment from the IRS. Jonathan took the standard deduction on his federal tax return in the
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previous year How should Jonathan report the refund and interest on his federal income tax return for the current year Okay we know from the previous questions that tax refunds whether they state or federal are typically not taxable
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So the question is, is interest from a tax refund taxable? Think about it
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Pause the video if you need to. And when you're ready, come back and we will look at the answer
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Okay, here's the answer. So the $2,000 refund is not taxable, but the $150 in interest is taxable
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Okay. So again, this video was about tax-exempt interest, but the idea is that you need to be able to know
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what interest is taxable and what interest is not taxable or is tax-exempt
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We learned a lot from this video, so let's do one final piece of the super-fast CPA strategy
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which is called pillar topics. Pillar topics is where you take everything you've learned from the previous questions that you just
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did or you could even do this during and take out the things that are obviously important
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that your review course is obviously trying to teach you. Again, these are the key two to four things
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that you were obviously supposed to learn from doing the questions. So let's go ahead and start making pillar topics
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All right. So municipal bond interest is not taxable. Interest from an HSA
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that has qualifying distributions distributions for medical expenses is not taxable interest from US E-Series savings bonds
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basically education savings bonds is also not taxable if distributions were for qualifying education
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expenses. And that would be qualifying education expenses would be for higher education expenses
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Tax refunds don't count as taxable interest or income. However, interest from a tax refund is taxable
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And that's one that could catch you. The reason that was in this video is because the tax
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refund typically isn't taxable. You might think that the interest from the tax refund is also not
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taxable, but that's not true. Interest from tax refunds is taxable. Typical things like interest
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from a savings account at your bank are taxable. Okay, so we learned a lot about different kinds
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of interest, and some of them are tax exempt, some are not. And that was the point of this video
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was to help you know what interest is typically excludable from gross income for an individual
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That's the end of this video. I hope you found it helpful. If you liked going through the questions as your main learning material, again, that's one of our main strategies is called question first. So make sure you go to superfast CPA.com to learn more and to watch the free one-hour webinar training where we go over the six key ingredients to passing the CPA exam. Also, we have the Superfast CPA app that has five-question mini quizzes, audio notes, and review notes that you can easily access on your phone throughout the day so that you make sure you're getting coverage throughout
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the whole day. Thanks for watching and I'll see you in the next one
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