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REG CPA Practice Questions: Adjusting Gross Income with Self-Employment and Other Items
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May 3, 2024
In this video, we walk through 5 REG CPA exam practice questions on adjusting gross income with self-employment deductions and other common deductions. 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-adjusting-gross-income-with-self-employment-and-other-items/ See the other REG walkthrough videos here: https://www.superfastcpa.com/free-reg-cpa-practice-question-walkthroughs/ 00:00 Intro 00:44 Question 1: SEP IRA Contributions 05:14 Question 2: Self-Employment Tax and Health Insurance Premium Deductions 08:04 Question 3: Schedule C and Schedule SE 09:48 Question 4: Student Loan Interest, Alimony and Self-Employment Tax 12:21 Question 5: Putting It All Together and Throwing in a Capital Loss 14:42 Pillar Topics
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0:00
Welcome to another Reg Walkthrough video
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I'm Logan, and in today's video, we're going to be going over adjusting gross income with
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self-employment and other expenses. And we're going to be doing that the SuperfastCPA way, which is diving straight into questions
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to learn the material. If you don't know much about our strategies, make sure to go to superfastcpa.com and watch
0:19
our free one-hour webinar, where we teach the six key ingredients to passing the CPA exam
0:24
Again, it's only one hour long, it's free, and it will save you months and months of struggling with your process
0:29
Also, be sure to check out our SuperfastCPA app, where we have five question mini-quizzes
0:34
that you can use on the go, so you can continually be practicing throughout the day
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The link to the webinar will be in the description, it will look like this. And with that said, let's go ahead and dive straight into the questions
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Here's question one. Matthew is a freelance graphic designer with a net self-employment income of $80,000 for
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the year. He is planning to contribute to a simplified employee pension individual retirement arrangement
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or SEPIRA. His self-employment tax for the year is $11,200. According to the IRS rules, he can contribute the lesser of 25% of his net earnings from
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self-employment, or a specific dollar amount set by the IRS for the year
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If the dollar amount limit set by the IRS for contributions is $58,000 for the year
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what is the maximum amount Matthew can deduct for his SEPIRA contribution
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All right, so there's a lot of info there. If you don't really know anything about SEPIRAs, that's okay
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That's the point of doing this. We're going to learn how being self-employed and the expenses that come along with that
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and some other expenses. We're going to learn how all those things affect an individual's gross income on their
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tax return. If you need to, make sure you pause the video, read through the question to make sure you
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understand it. And once you're ready, let's go ahead and go to the answer
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All right, so he's able to contribute $18,600. So let's learn about that
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So when it comes to SEPIRAs, here's the calculation. So first you have net self-employment of the 80,000 and then you deduct part of the
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self-employment tax. So 50% of the self-employment tax. Okay. And this net earnings number is the number you then use against this 25% and that will
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give you the max contribution he can give to his SEPIRA. So let's go over that one more time
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$80,000 less 50% of the self-employment tax that gives you net earnings
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Then you multiply that number of net earnings by the 25% limit and that gives you the $18,600
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And since that $18,600 is less than the max cap right here, he can deduct that full $18,600
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from his gross income. Let's learn a little bit more about SEPIRAs and how they compare to some other retirement options
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So for SEPIRAs, contributions to an SEPIRA are made pre-tax and reduce taxable income
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for the year. The amount contributed up to the allowable limit can be deducted from the individual's
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gross income, lowering the adjusted gross income and potentially reducing the overall
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tax burden. So pretty simple. Once you get this net earnings calculation down and then you multiply it by whatever
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the contribution limit is, whether it's 25% or 20% varies from year to year, then that
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gives you the amount of contribution that can be used to reduce somebody's gross income
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Let's learn a little bit about self-employed 401ks or they're also called solo 401ks
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These are specifically designed for self-employed individuals with no employees other than a spouse
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Contributions to a solo 401k can be made in two parts or in two ways
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First, as an employee deferral and as employer profit sharing contributions. The combined amount reduces the individual's taxable income
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Employee deferrals are made pre-tax and reduce gross income directly. Employer contributions are deductible as a business expense and reduce business taxable
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income, which in turn lowers the individual's gross income if they are self-employed
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So just letting you know, self-employed 401k or a solo 401k, you might not see it on the
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reg exam, but I did want to point out that it is different than an SEP IRA
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It's a little bit more of a specific situation. So I just wanted to make sure you know it exists, but you probably won't have to deal
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with it too much, but they are different than SEP IRAs. And then there is the traditional 401k
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We didn't go over this in the HSA and IRA video. We completely focused on IRA retirement options in that video, but there are traditional 401ks
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where if you contribute to a 401k, it's pre-tax and it can reduce your gross income
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Employer contributions for a 401k do not affect the employee's gross income directly
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However, for the employer, their contributions are deductible business expenses, which reduce
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the taxable income of the business. So basically the main thing that I wanted you to learn from this question was about
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how SEP IRA contributions can reduce the gross income of an individual
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But SEP IRAs are different from self-employed 401ks or solo 401ks and from traditional 401ks
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The idea is generally the same that contributions can affect their gross income specifically
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with SEP IRAs. There is this calculation that you have to do where you figure out the net earnings after
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you deduct half of the self-employment tax, and then you can use the SEP IRA contribution
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limit and that will give you how much of the contribution can be used to reduce gross income
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So that was a lot to go over in one question. Let's go ahead and go to the next question and see what else we can learn
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Here's question two. Elena is a self-employed consultant who has a net profit of $120,000 from her consulting
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business this year. Her self-employment tax amounted to $16,920. Additionally, she paid $7,000 for health insurance premiums for herself
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Elena has moved to a new city this year for personal reasons and incurred $3,000 in moving expenses
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She is not a member of the US military. Which of the following statements accurately reflects how these items affect Elena's adjusted
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gross income? All right, so there's some new things here. You might not know how these affect somebody's gross income
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So if you need to take a second, read through the question and the possible answers, see
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if you can figure it out yourself. And when you're ready, come back and we'll look at the answer to learn more about what
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can affect an individual's gross income. All right, here's the answer. Elena can deduct $8,460 of self-employment tax, $7,000 of health insurance premiums
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but not the moving expenses, reducing her AGI to $104,540. So let's learn a little bit more about how this works
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Elena can deduct half of her self-employment tax, amounting to $8,460, and her health insurance
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premiums of $7,000, but not her moving expenses, since she is not a member of the US military
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moving for military purposes. Okay, so there's three different things here. So first let's talk about self-employment tax
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Self-employed individuals can deduct the employer equivalent portion of their self-employment tax
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In other words, 50%. In this case, Elena can deduct half of her self-employment tax, and that gives you the $8,460
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So that's the general rule right there. Most of the time, if not all the time, for self-employed individuals who have self-employment
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tax, they can deduct half of that self-employment tax from their gross income
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And then let's look at self-employed health insurance. Elena can also deduct her self-employed insurance premiums, which total $7,000
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This deduction is available to self-employed individuals and is used to reduce AGI
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The deduction cannot exceed the net profit from the business from which the health insurance is established
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So generally and simply, self-employed individuals can deduct their self-employed health insurance
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premiums, but that amount cannot exceed their net profit, which, you know, makes sense because
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their gross income can't go below zero. It doesn't go negative. And then moving expenses are no longer generally deductible for most taxpayers after the Tax
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Cuts and Jobs Act, except for active duty members of the U.S. armed forces moving under
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military orders. So easy enough, moving expenses are not deductible for anybody unless they are in the military
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and they are moving specifically for military reasons. And to finish, here's the calculation right here
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So they take $120,000 less half of the self-employment tax and less the health insurance premiums
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So that gives you the $104,540. Not too difficult there. Let's go to the next question
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Here's question three. Lewis is a self-employed web developer who reports his income and expenses on Schedule
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C. This year, Lewis's gross revenue from his web development business was $90,000
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He incurred $30,000 in various business expenses that are deductible on Schedule C, including
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advertising, software subscriptions, and home office expenses. Lewis's self-employment tax for the year calculated on Schedule SE
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By the way, that's where you calculate all this self-employment stuff, Schedule SE, based
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on his net profit is $8,480. How do these figures affect Lewis's adjusted gross income? Okay
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So there are three questions in. You've learned a lot. You actually could probably figure this question out
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So take a second, pause the video, read through the question again, read through the answers
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and take what we've learned from the previous two questions about self-employment tax and
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net profit from self-employment and things like that, and see if you can figure out his AGI
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And when you're ready to come back and we will look at the answer. Okay, here is the answer
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So Lewis can deduct the $30,000 in business expenses on Schedule C, reducing his net profit
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to $60,000. And then he takes half of his self-employment tax and that gives him an AGI of $55,760
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So basically that, you know, that's maybe a little bit confusing, maybe worded a little bit weird, but basically somebody who uses a Schedule C because they're self-employed
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they have all their income from their business, from their self-employed business, and then
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they have all of their business expenses and together on the Schedule C you get a net profit
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and that net profit is part of the taxpayer's income, right? And then you can deduct half of the self-employed tax from that net profit and that gives the AGI
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So again, pretty simple. You probably were able to do that. Let's go to the next question
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Here's question four. Charlie, a self-employed graphic designer, had a gross income of $95,000 this year
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He paid $3,200 in interest on a qualified student loan. According to the tax regulations, the maximum deductible amount for student loan interest
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is $2,800 for the year. Charlie also made alimony payments under a divorce agreement executed in 2017
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He paid $12,000 in alimony. His self-employment tax calculated on Schedule SE is $13,400
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So considering all of these things, how do these affect his AGI
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Okay, so you could probably figure out a lot of this. So go ahead, pause the video, see if you can figure out the correct answer based off of
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what we learned and based off of maybe any other prior knowledge you have
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And when you're ready, come back and we will look at the answer to learn a little bit more about maybe how alimony affects it, how does student loan interest affect it
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So come back when you're ready. All right, here is the correct answer
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So he can reduce his AGI by the student loan interest limited to $2,800
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The alimony of $12,000 and half of his self-employment and that reduces it all results in the $73,500
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So let's learn a little bit more. So Charlie paid $3,200 in student loan interest, but he can only deduct up to the limit of $2,800
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So just letting you know that $2,800 isn't necessarily the current year number
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That's not what we're trying to teach you. What I'm trying to teach you is that there is a limit to how much student loan interest
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can be taken. I think right now it's $2,500, but again, tax numbers change from year to year
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So that's not important. What you need to know is that there is a limit and any amount at that limit or below that
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limit can be used again to reduce their gross income. Alimony payments are deductible for agreements executed before 2019
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So he can deduct the full amount of $12,000 for agreements executed in or after 2019 alimony
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payments are not deductible. So this is something that comes up in a lot of different things, but alimony, you know
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alimony that a person pays to another person because they got divorced used to be deductible
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for the person paying it and taxable for the person receiving it before 2019
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But as of 2019 and all years after, you know, up until now, alimony paid is not deductible
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from the gross income of the individual paying and alimony received is no longer taxable
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So in this situation, because it was in 2017, that $12,000 is deductible from his gross income
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And he can deduct as you've seen before, half of his self-employment tax
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So that all together gives him $73,500 of AGI. All right. We've just been seeing lots of little things that can adjust AGI
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So let's go to the last question to see if we can put it all together. All right
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Here's question five. Jordan is a self-employed digital marketing consultant. Lots of people working in digital media who reports a net income of $100,000 on schedule
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C. He wishes to maximize his contribution to his SEP IRA, which is limited to 20% of
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his net earnings from self-employment after deducting the self-employment tax deduction. This year, Jordan also experienced a capital loss of $6,000 from the sale of some stock
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investments with no capital gains to offset his loss. His self-employment tax for the year is calculated to be $14,130
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What is Jordan's adjusted gross income or AGI? Okay. This is the last question of the video
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See if you can figure it out. The one thing that could be a curve ball is if you don't remember or don't know how capital
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losses are treated. But other than that, you should know how to figure this out
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So again, pause the video, see if you can get the correct answer. And when you're ready, come back and we will look at the answer. Okay
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Here is the answer. So his AGI is $71,348. And here's the calculation
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So we take his net income, we deduct half the self-employment tax. So that's $7,065
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And that gives us the net earnings that we then multiply by 20% to get 18,587
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So 18,587 is the maximum amount that he can contribute to his SEP IRA
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And it said that he wanted to contribute the maximum amount. So that's what he's doing. 18,587
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And then just a reminder in case you didn't know how to do this or you'd seen this but
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forgot with capital losses, net capital losses after netting them against capital gains and
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everything, only $3,000 of those capital losses can be used to deduct, to adjust gross income
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for an individual. The remaining amount after that 3000 is carried forward to future years to be used against
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capital gains. But what you need to remember from this video is that when it comes to adjusting gross income
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only $3,000 of net capital losses can be used to reduce an individual's gross income
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So with all of that, taking his $100,000 less the SEP IRA contribution
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And again, he maxed that out and less half of his self-employment and then less the $3,000
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capital loss that gives you $71,348. All right, there was a lot of things in this video
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Before we finish, let's do one more part of the Superfast CPA strategy, which is something
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called pillar topics. So pillar topics is pretty simple. As you're going through the questions learning material, you're going to notice things that
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are obviously important. You'll see a topic come up three or four times across different questions
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And you'll know after doing the questions or even during the questions, what topics
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and what concepts are most important according to your review course that you need to know
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for the CPA exam. So we're going to take a second and think through all of those questions that we just
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went through and pull out the pillar topics. So let's start with SEP IRAs are limited by a percentage of net self, oops, self-employment earnings
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So let's put the calculation for net earnings. So net earnings is net self-employment profit, less half of the self-employment tax
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And then you multiply, multiply net earnings by the current year contribution percentage
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limit, something like 20% or 25%. And that gives you the max contributions for an SEP IRA
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And then half of self-employment tax is deductible. Self-employed health insurance premium, oops, insurance premiums are deductible up to total
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net profit. So it's limited by the net profit. Alimony can be deducted if for a divorce for 2019, capital losses can reduce by up to $3,000
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And finally, moving expenses are not deductible except for active duty military who moves
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for military reasons. Okay, those are some of the pillar topics that I could pull out from that
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Again, pillar topics is what seemed most important to you. So maybe there were some pillar topics that you thought of that I didn't think of, or
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maybe you want to add more detail, or maybe you want to make it a little bit more simple
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But the great thing about pillar topics is it's you taking a second and realizing what
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is important from what you just learned. All right, that's the end of the video
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Thank you for watching. If you liked this, make sure you go to superfastcpa.com to watch our free one-hour webinar training
17:20
where we go over the six key ingredients to passing the CPA exam
17:24
And if you liked going through the questions as your main learning material, make sure you check out our SuperfastCPA app where we have five question mini quizzes so you can
17:32
practice all throughout your day. Again, thanks for listening, and I will see you in the next video
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