Solutions

CHAPTER 9

DISCUSSION QUESTIONS

1. Unless moving expenses are involved, Lyle’s expenses will be deductions from AGI.Therefore, the deduction would not be available if the standard deduction is claimed.Also, Lyle’s expenses will be subject to the 2%-of-AGI limitation. Lyle’s expenseswould be reported on Form 2106 and transferred to Schedule A. Joan’s expenses aredeductions for AGI and should be reported on Schedule C. Lyle will be subject to FICA,whereas Joan is liable for the self-employment tax. pp. 9-3 and 9-29

2. Each stylist should pay a set rental for the use of the facility. Except for controlling thehours when the salon will be open, Bernard should allow each stylist to determine his orher own working hours. Each stylist should handle customer appointment and billingfunctions. To the extent feasible, stylists should provide their own tools and supplies.Preferably, each stylist should have a separate telephone. Except in the interest of publichealth or safety, Bernard should exercise no control over the clientele of his stylists.p. 9-3

3. Alexis can claim the mileage from her home to the client locations. The mileage to andfrom the university qualifies as an education expense. p. 9-15 and Examples 7 and 27

4. In terms of income derived, the newspaper column he writes predominates. Since thecolumn is written at home, this would be considered his tax home. In this sense, the tripsto the university can be regarded as going to a second job. Consequently, the use of hiscar for this purpose should be deductible. pp. 9-5, 9-8, and Example 5

5. From the facts given, it appears that Emma has never claimed any deduction for thebusiness use of the auto. If she has already filed for year 2003, an amended returnclaiming the deduction is appropriate. Due to an absence of records, Emma cannot usethe operating cost method of determining the deduction. Consequently, the automaticmileage method should be chosen. Emma can prove the miles driven and the percentageof business use. pp. 9-6 and 9-7

6. Tyler’s deductible expenses include transportation and meals and lodging for the entiretrip. Expenses attributable to the Cub’s game and the museum trips are personal and arenot deductible. Because the trip is solely for business and business was conducted onFriday and Monday, the weekend living expenses are regarded as business expenses.p. 9-10 and Examples 10 and 20

7. The main issue to be resolved is the location of Dr. Werner’s tax home. Presuming hissalary to be more than modest, the tax home probably is the situs of Pelican University.Thus, Dr. Werner is in travel status when he conducts continuing education programs ortestifies while out of town. p. 9-8

8. Expenses incurred during a temporary assignment will be treated as if the taxpayer is intravel status, as the tax home does not change. If, however, the assignment is indefinite,the tax home changes to the location of the new assignment. If the period of assignmentexceeds one year, it is not temporary. p. 9-8 and Examples 10 and 11

9. a. A taxpayer is never away from home if his or her job is the tax home. Suchwould be the case of the itinerant worker or trucker who lives where they work.

b. If the taxpayer is never away from home, then all living expenses, such as mealsand lodging, become personal and are nondeductible.

Deductions: Employee and Self-Employed-Related Expenses 9-5

c. The key to being away from home for tax purposes is the duplication of livingexpenses. For example, the truck driver who otherwise sleeps at home will beduplicating lodging expense when a motel room is rented while on the road.

p. 9-8 and Example 12

10. Dr. Hampton’s expenses clearly are deductible, while those relating to Mrs. Hampton arenot. Although she is employed by the clinic, the content of the seminar probably is notrelevant enough to her job assignment. Contrast Examples 16 and 17. p. 9-9

11. If obtaining the education does not qualify as a deduction, related travel expenses are notallowed. Thus, none of these expenses are deductible. p. 9-9 and Example 18

12. Travel days count as business days. The weekend counts as business days if the priorFriday and subsequent Monday are business days. The same holds true for a legalholiday. By utilizing these guidelines, Marge can enhance her leisure time whilemaximizing her deductions. p. 9-10

13. Quincy did not satisfy the 39-week time requirement. So he has two choices. First, hemay increase his income for 2006 by the amount of moving expenses deducted on the2005 tax return. Second, he can file an amended return for 2005 and recompute his taxafter deleting the moving expenses deduction. p. 9-12

14. First, storage expenses qualify for the deduction for expatriates. Second, the time testdoes not apply when the expatriate returns to the U.S. to retire. Global Tax Issues onp. 9-13.

15. a. Nondeductible expenses would include those that are not job related (e.g., anaccountant’s expenses incurred in obtaining a law degree) or those involved inacquiring a basic skill (e.g., cost to an accountant of taking a review course for theCPA exam). pp. 9-13 and 9-14

b. If the expenditure falls under § 222, it is classified as a deduction for AGI.Section 222 includes only qualified tuition and related expenses. pp. 9-15 and9-16

c. All other education expenses (i.e., those not disallowed in part a. or included inpart b. above) are treated as deductions from AGI. pp. 9-15 and 9-28

16. a. One of the advantages of § 222 is that the education involved need not be jobrelated.

b. As a deduction for AGI results, the 2%-of-AGI limitation is not applicable.

c. The AGI limitation and the related partial or complete phaseout of the deductiondepends on the year involved and the filing status of the taxpayer.

d. Section 222 is not available when married taxpayers file separate returns.

p. 9-16 and Table 9-1

17. Because business entertainment involves an element of pleasure, such entertainmentshould not be completely deductible.

9-6 2006 Comprehensive Volume/Solutions

a. The original scapegoat was the “three-martini lunch.” The cutback adjustmentdoes not preclude any deduction, but merely reduces the amount that can bededucted.

b. The cutback adjustment is further reduced for taxpayers whose employment isregulated by the U.S. Department of Transportation. This group is unlikely to usebusiness meals for pleasurable purposes.

p. 9-17

18. a. The employee is subject to the 50% cutback adjustment. p. 9-17 and Example 29

b. The employer is subject to the 50% cutback adjustment. p. 9-17 and Example 29

a. Neither is subject to the cutback adjustment. The award is compensation to theemployee and is fully deductible by the employer. p. 9-18 and Example 31

d. No one is subject to the cutback adjustment. The subsidized eating facilityprovision represents one of the exceptions to the cutback adjustment rule. p. 9-18 and Example 32

e. Employer paid recreational activities are not subject to the cutback adjustment.p. 9-18

f. De minimis fringe benefits are not subject to the cutback adjustment. p. 9-18 andExample 33

19. The membership dues to the club are not deductible nor are any of the expenses relatingto personal use deductible. The business lunches qualify if properly substantiated. Theexpenses for the golfing activities may be difficult to deduct in view of Madison’s lack ofparticipation. Like the Christmas party, however, the expenses could qualify if precededor followed by a bona fide business discussion (or presentation). Neither the golf coursenor the Christmas party can be regarded as a clear business setting. pp. 9-19, 9-20, andExample 36

20. Since the tickets were purchased at the last minute, a premium was probably paid. Onlythe cost of regular tickets (as measured by their face value) is deductible. Any suchdeduction is subject to the 50% cutback rule.

If the entertainment is of the “associated with” variety, attendance at the game must bepreceded or followed by a bona fide business discussion. In addition, a partner or anemployee of the law firm must be present during the game. p. 9-20 and Example 37

21. a. An employee who claims the standard deduction cannot benefit from an office inthe home deduction since it is an itemized deduction. A self-employed taxpayer,however, can benefit since a deduction for AGI now is involved.

b. The office must be used exclusively for business. Otherwise the home office isnot a qualified home office.

c. Excess expenses can be carried over to future years.


d. Instead of deducting interest on home mortgage, property taxes, and depreciation,claim an allocable portion of the rent. Such items as utilities, repairs,maintenance, and renter’s insurance are eligible for deduction.

pp. 9-20 to 9-22 and Example 39

22. Myrna should claim $400 (employee reimbursed expenses) and $250 (school suppliesprovision) as deductions for AGI. The balance of $750 is a deduction from AGI and willbe subject to the 2%-of-AGI floor. Further, the $750 will not be available if Myrnachooses the standard deduction and does not itemize. p. 9-23 and Example 40

23. Since this seems to be Trent’s first job, his job search expenses would not qualify fordeduction. His moving expenses, however, should qualify as deductions for AGI. In thisregard, the move covers Florida to New Orleans (rather than Vanderbilt to New Orleans)because college attendance normally does not establish residency. pp. 9-12, 9-13, and9-23

24. a. Under a traditional IRA, a contribution is deductible, income accumulates tax-deferred, and distributions are fully taxed. Under a Roth IRA, no deduction isallowed for the contribution, income accumulates tax-free, and distributions arenot subject to tax.

b. A traditional IRA and Keogh (H.R. 10) plans follow the same pattern of adeduction followed by a deferral of income tax. IRAs, however, generally arisein an employment setting (i.e., taxpayer is an employee); whereas Keoghs areavailable to those who are self-employed.

p. 9-24

25. No deduction will be allowed unless the credit card receipts also reflect the businesspurpose of the expense and the business relationship of Nicholas to the personentertained. p. 9-25

26. a. The reimbursements and expenses are omitted from the return.

b. No reporting is required. Provided the other substantiation requirements are met,the amount of the expenses is deemed substantiated at the Federal per diem rate.

c. All reimbursements are reported as additional wages (gross income) and theexpenses (except moving) are deductible from AGI subject to the 2% of AGIfloor. Both Form 2106-EZ (Unreimbursed Employee Expenses) and Schedule Aare used. If, however, the employee makes use of the standard deduction, he orshe is in the unfortunate position of having to report the reimbursements in grossincome with no deduction for the expenses.

pp. 9-25 to 9-27

27. To avoid not being in a trade or business, Olivia should try to obtain a temporary leave ofabsence from her employer. As long as any such leave is not unduly prolonged, she willstill be regarded as being in a trade or business for purposes of claiming the educationexpense deduction as an itemized deduction. She will not be deemed as having acquireda new trade or business—a graduate degree in tax merely maintains or improves existingskills of an attorney. Note that under § 222 (deduction for qualified tuition and relatedexpenses), Olivia does not have to be concerned about the leave being temporary.


However, the maximum amount that can be deducted under § 222 in 2005 is $4,000. The§ 222 deduction is a deduction for AGI. pp. 9-14 and 9-31

28. It would be unwise for Kim to choose the $48,000 option due to the tax consequencesinvolved. This option makes her subject to the 50% cutback adjustment for businessmeals and entertainment. But even the portion of these expenses allowable as deductionsmay not benefit Kim unless she is in a position to itemize her deductions (i.e., forgo thestandard deduction). Furthermore, the expenses are subject to the 2% of AGI floor.

If on the other hand, Kim selects the $35,000 option, Crane Corporation must suffer the50% cutback adjustment.

pp. 9-17, 9-30, and 9-32

29. The first major tax problem Jeff is apt to encounter is the inability to deduct his movingexpenses. This problem can be avoided if Jeff would satisfy either the 39-week rule(employee) or the 78-week rule (self-employed) once he moves to New Mexico. Being aphysician, chances are good that Jeff would have little difficulty obtaining work in themedical field. Keep in mind that it is full-time employment that is required; the incomelevel of such employment is immaterial. pp. 9-12, 9-31, and Example 45

30. a. If the trip is more than 100 miles from home and includes an overnight stay, adeduction for AGI is allowed. The deduction is limited to the maximum Federalper diem rate applicable to the geographical area involved. Tax in the News onp. 9-29

b. Deduction from AGI and subject to the 2%-of-AGI floor. p. 9-22

c. Deduction from AGI and subject to the 2%-of-AGI floor. As the taxpayer is notan elementary or secondary school teacher, the school supplies provision of $250does not apply. Example 40

d. Nondeductible, as the IRS maintains that acquiring a law degree or taking the barexam is qualifying for a new trade or business. p. 9-15

e. Nondeductible, as job-hunting expenses must involve the same trade or business.Switching from teacher to stockbroker involves different trades or businesses.p. 9-23

f. Nondeductible, as not directly related to the taxpayer’s trade or business (i.e.,dentistry). Example 13

g. Safety clothing, if related to the job, is deductible. Since the taxpayer is self-employed, a deduction for AGI results. p. 9-23

PROBLEMS

31. a. 50 work weeks X 5 days = 250 days X 25 miles = 6,250 miles. The deductionallowed is determined by the distance between the two jobs. The fact that Marlonmight return home before going to the second job is immaterial. p. 9-5 andExample 5


b. Since Marlon is not in travel status or business entertainment is not involved, thecost of meals is a nondeductible personal expense. p. 9-7

32. $2,916. 240 days X [(10 miles + 8 miles + 12 miles) X $0.405 (automatic mileage ratefor 2005)]. pp. 9-5, 9-6, and Example 6

33. a. Nelson’s adjusted basis is determined as follows:

Cost of automobile $38,000Less depreciation (under automatic mileage method):

2003 (15,000 miles X 90% X 16 cents) (2,160)2004 (20,000 miles X 90% X 16 cents) (2,880)2005 (18,000 miles X 90% X 17 cents) (2,754)

Adjusted basis of auto on 1/1/06 $30,206

pp. 9-6, 9-7, and Example 9

b. Cost of automobile $38,000Less depreciation (allowed under actual operating

cost method—see below*) (9,819)Adjusted basis of auto on 1/1/06 $28,181

*Depreciation allowed is the lesser of the table amount (Table 8-1 on p. 8-27) orthe recovery limitation (p. 8-14).

DepreciationYear Table Amount Recovery Limitation Allowed

2003 $38,000 X 20% X 90% = $6,840 $3,060 X 90% = $2,754 $2,7542004 $38,000 X 32% X 90% = $10,944 $4,900 X 90% = $4,410 4,4102005 $38,000 X 19.2% X 90% = $6,566 $2,950 X 90% = $2,655 2,655Total depreciation allowed $9,819

Example 19 in Chapter 8

34. a. Travel days count as business days and weekends also count as business dayswhen preceded (i.e., Friday) and followed (i.e., Monday) by business days. ForMargaret, Thursday is a personal day. Margaret’s deductible expenses aredetermined below:

Airfare $2,200Lodging (6 nights X $150) 900Meals (5 days X $130) X 50% (cutback adjustment) 325Total $3,425


b. As Margaret was way from home for seven days, all of the airfare is deductibleand no apportionment is required. [Note: Margaret also passes the less than 25%for personal purposes test (i.e., one day out of eight is less than 25%)].Consequently, Margaret’s deductible expenses are $3,425—as determined in parta. of this problem. pp. 9-10, 9-11, Examples 22, 23, and Footnote 18


c. Because Margaret is self-employed, a deduction for AGI results. p. 9-3

35. a. Graham’s assignment is temporary (not indefinite), so his tax home has notchanged. While in Cheyenne, therefore, he is in travel status. The deductibleportion of his weekend expenses is limited to $320, the amount he would havespent had he not gone home.

b. The answer will not change and remains at $320 but for a different reason. Adeduction is always limited to the amount actually spent.


36. Although they may be very useful to their family, Mrs. Lord’s activities do not constitutea trade or business. Consequently, her expenses at the conference are not deductible.

Alvin’s deductible expenses are as follows:

Airfare (one ticket) $ 520Lodging 660Meals ($100 X 3 days) $300Less: cutback adjustment (150) 150Registration fee ($520 – $120) 400Car rental 240Total $1,970

p. 9-9 and Examples 13, 14, and 16

37. a. Justin’s trip is treated as being 100% for business. Weekends and holidays arebusiness days when preceded and followed by business days. Travel days arebusiness days and (though not mentioned in the text) this should include dayswhen travel is not possible (e.g., equipment failure, weather delays).

b. Yes, as this causes Saturday, Sunday, and Monday to be nonbusiness days.

c. Under the assumptions in part a., all of the airfare would be deductible. This isalso the case regarding part b. because of the 7-days-or-less exception. Under theexception, the day of departure is not counted. Consequently, Justin’s trip lastedfrom Friday to Thursday, or seven days.

p. 9-10 and Footnote 18

38. a. Thirteen days. Since travel days count as business, and weekends count asbusiness when preceding and succeeding days are business days, all of herabsence is regarded as business.

b. If Monica does not satisfy the 7-day or less-than-25% tests, then part of hertransportation cost is not deductible.

c. Monica cannot satisfy the 7-day test because she was away from home for morethan 7 days. Under the less-than-25% test and not counting partial days, shecould have vacationed for three more days assuming the days did not interferewith the preceding and succeeding days provision.



39. a. The job search expenses are not included in the moving expense category but aredeductible as miscellaneous itemized deductions. As such, they are classified asdeductions from AGI. Further, they are subject to the 2%-of-AGI floor.

The loss on the sale of the personal residence is not a qualified moving expense.It is treated as a personal loss and is not deductible. Also, meals during the moveare not included in allowable moving expenses.

The deduction for AGI as to qualified moving expenses is as follows:

Packing and moving expenses for household goods $6,000Lodging during move 620Mileage (6,600 miles X $0.15) 990Total deduction $7,610

b. It appears that accounting and human resources are different trades or businesses.If so, the job search expenses become nondeductible. The change in jobdescriptions does not, however, affect the allowance of the moving expensededuction.

pp. 9-11 to 9-13, 9-23, 9-28, and Example 25

40. a. At most, $4,000 of the tuition could be a deduction for AGI. This assumes thatthe AGI limitations of § 222 are not exceeded ($65,000 for an unmarried returnand $130,000 for a joint return). As Garth spent $4,300 on tuition, the § 222deduction for AGI is limited to $4,000.

b. Presuming $4,000 is claimed under § 222 [see part (a.) above], the deduction fromAGI is as follows:

Tuition ($4,300 – $4,000) $ 300Books and course materials 650Lodging 1,200Meals ($1,600 X 50% cutback adjustment) 800Laundry and dry cleaning 220Campus parking 300Auto mileage ($1,500 miles X $.405) 608Total deduction from AGI $4,078

pp. 9-15, 9-16, and Examples 27 and 28

41. a. $4,000. The education does not have to be job related.

b. $1,900. A second category of AGI (more than $65,000 and up to $80,000) foryears 2004 and 2005. However, only the amount spent for tuition qualifies.

c. Zero, as to a., because pursuing a law degree is treated as qualifying for a newtrade or business. As to b., the $200 not allowed for books qualifies as theeducation is job related.

pp. 9-14 to 9-16

42. a. Calvin must include the travel allowance of $12,000 ($1,000 X 12 months) ingross income. He may claim the following as deductions from AGI.


Lodging $13,600Meals $12,480Less: cutback adjustment (30% X $12,480)* (3,744) 8,736

$22,336

*Calvin is regulated by the U.S. Department of Transportation.

The travel expenses also will be subject to the 2%-of-AGI floor.

b. Since these expenses considered alone clearly exceed the standard deduction,Calvin should itemize his deductions from AGI. But note that Calvin is on theroad for 44 weeks out of the year. This may mean that he is not away from a taxhome (i.e., expenses are not duplicated). If this is the case, he is not in travelstatus. Because meals and lodging expenses would then not be deductible,claiming the standard deduction could be more beneficial.

pp. 9-8, 9-17, and Example 12

43. a. Grebe Associates may deduct the following amounts:

Cost of seats ($70 X 20) $1,400Food and beverages 450Total entertainment expenses $1,850Less: 50% cutback adjustment (925)Total deduction $ 925

b. No. The deduction is determined by the seats available and not those occupied.


44. $116. ($27 + $25 + $20) + ($88 X 50%). No deduction is allowed for the gift to George,since he is Kevin’s boss. The deduction for the gift to John is limited to $25. Thededuction for the gifts to Darlene is limited to $27 ($25 + $2 for gift wrapping isallowed). Subject to the cutback adjustment, the lunch also is deductible. p. 9-20

45. a. The office in home expenses are $3,500, calculated as follows:

Real property taxes (20% X $4,000) $ 800Interest on home mortgage (20% X $5,000) 1,000Operating expense of home (20% X $1,000) 200Allocable depreciation 1,500

$3,500

When combined with other expenses of the business ($3,200), the total of $6,700exceeds the income from the business by $1,200 ($6,700 – $5,500). Thus, thedepreciation allowed is limited to $300 ($1,500 – $1,200), making the deductibleoffice in the home expense $2,300. The nondeductible $1,200 can be carriedforward to future years.

b. Since Brittany is self-employed as to her financial planner business, all of thesetransactions end up on Schedule C of Form 1040 (i.e., deductions for AGI). First,however, Form 8829 (Expense for Business Use of Your Home) must becompleted.


The remainder of the property taxes of $3,200 (80% X $4,000) and mortgageinterest expense of $4,000 (80% X $5,000) not involved in the home office willqualify as itemized deductions (deductions from AGI) and can be claimed onSchedule A of Form 1040.

pp. 9-20 to 9-22 and Example 39

46. Victor must first make an allocation to determine the appropriate portion of thereimbursement that applies to meals and entertainment and to other employee expenses.

$3,200 (meals) + $2,200 (entertainment) = 36%$14,900 (total expenses)

Consequently, of the $10,000 reimbursement, 36%, or $3,600, applies to meals andentertainment and 64%, or $6,400, applies to the other employee expenses. Thedeductions for AGI and from AGI are reported on Form 2106 in the following manner:

Other thanMeals and Meals and

Entertainment EntertainmentLodging $3,400Transportation 5,200Professional dues and subscriptions 900Meals ($3,200) and entertainment ($2,200) $5,400Total expenses $9,500 $5,400Less: reimbursement (deductible for AGI) (6,400) (3,600)Unreimbursed portion $3,100 $1,800Less: cutback adjustment (900)Unreimbursed deduction from AGI $3,100 $ 900

The totals from Form 2106 are reported on Schedule A, then reduced by 2% of AGI:

Total unreimbursed employee expenses ($3,100 + $900) $4,000Less: 2% of $94,000 AGI (1,880)Total deduction from AGI $2,120


47. Cole must make an allocation to determine the appropriate portion of the reimbursementthat applies to meals and entertainment and to other employee expenses:

$7,200 ($4,100 meals + $3,100 entertainment) = 33% $21,700 (total expenses)

Consequently, of the $15,000 reimbursement, $4,950 (33% X $15,000) applies to mealsand entertainment and $10,050 (67% X $15,000) pertains to the other employeeexpenses.

The deductions for AGI and from AGI are reported in the following manner:



Entertainment EntertainmentAirfare $ 9,200Lodging 5,300Meals $4,100Entertainment 3,100Total business expenses $14,500 $7,200Less: reimbursement (deductible for AGI) (10,050) (4,950)Unreimbursed portion $ 4,450 $2,250Less: cutback adjustment (1,125)Unreimbursed deduction from AGI $ 4,450 $1,125

The totals from Form 2106 are reported on Schedule A and are reduced by 2% of AGI asfollows:

Total unreimbursed employee expenses ($4,450 + $1,125) $5,575 Less: 2% of $98,000 (AGI) 1,960 Total deduction from AGI $3,615


48. As the employer did not identify what the reimbursement was for, Audry must allocate itbetween the items that are and are not subject to the cutback adjustment. The percentageapplicable to the cutback portion is determined as follows:

$5,000($2,800 meals + $2,200 entertainment)$15,000 (total expenses) = 33 1/3%

Thus, $1,500 (33 1/3% X $4,500) of the reimbursement applies to meals andentertainment while the balance of $3,000 ($4,500 – $1,500) relates to the otheremployee expenses.

Audry’s AGI is: $59,000 (salary) + $1,600 (interest income) – $2,000 (long-term capitalloss) = $58,600.

The deductions for and from AGI are determined as follows:


Entertainment EntertainmentTransportation $ 5,500Lodging 4,200Professional dues and subscriptions 300Meals and entertainment ($2,800 + $2,200) $5,000 Total employee expenses $10,000 $5,000 Less: reimbursement (treated as deduction for AGI) (3,000) (1,500)Unreimbursed expenses $ 7,000 $3,500 Less: cutback adjustment (1,750)Unreimbursed deductions from AGI $ 7,000 $1,750


These items are reported on Schedule A and are reduced by 2% of AGI as follows:

Total unreimbursed employee expenses ($7,000 + 1,750) $8,750 Less: 2% of $58,600 (1,172)Total employee deductions from AGI allowed $7,578


49. a. The Pitt’s AGI for 2005 is computed as follows:

Salaries ($51,750 + $48,000) $99,750Contributions to traditional IRAs (8,000)Short-term capital gain 3,000AGI $94,750

b. Itemized deductions subject to the 2%-of-AGI limitation are determined asfollows:

Union dues (Note 1) $ 1,200Safety clothing 500Professional dues and subscriptions 400Refreshments for school picnic (Note 2) 200Correspondence study course (Note 3) 320

$ 2,620Less: 2% X $94,750 (AGI) (1,895)Deductible portion $ 725Add: other itemized deductions 13,100Total deductions from AGI $13,825

Notes

(1) It is presumed that the Pitts are cash basis taxpayers. Thus, the union dues aredeductible in the year paid.

(2) Eva’s participation in the cost of the school picnic is related to her job as ateacher.

(3) Considering the composition of Eva’s classes (i.e., sixth grade), thecorrespondence study course is job related, as it would improve her teachingeffectiveness.


CUMULATIVE PROBLEMS

50. Salary $70,000 Performance bonus (Note 1) -0- Travel and entertainment allowance (Note 2) 24,000 Employee discount (Note 3) 300 Other income (Note 4):

Interest income (Note 5) 1,160 Dividends (Note 6) 940


Contribution to IRA (4,000)Adjusted gross income $92,400 Personal exemption (3,200)Itemized deductions:

Not subject to 2% limitation (Note 7) $10,670Subject to 2% limitation (Note 8) 24,366 (35,036)

Taxable income $54,164

Tax liability (Note 9) $10,112Less: Estimated tax payments (11,000)Net tax payable (or refund due) for 2005 ($ 888)

Notes

(1) The bonuses are taxed to Brenda in the year received. Thus, the 2004 bonus of$12,000 is taxed in 2004 and the 2005 bonus of $15,000 is taxed in 2006.

(2) The allowance Brenda receives is income and cannot be offset against herexpenses. Because she does not account to her employer, all employment-relatedexpenses are classified as deductions from AGI and will be subject to the 2%limitation.

(3) Pursuant to § 132(c)(1), qualified employee discounts are exclusions from grossincome. But the exclusion cannot exceed the equivalent of the gross profitpercentage. In Brenda’s case, this means an exclusion of $600 and income of$300, determined as follows:

Retail price of clothing $3,000 Less: gross profit (20%) (600)Nontaxable discounted price allowed $2,400 Cost to Brenda [$3,000 – (30% X $3,000)] 2,100 Taxable discount $ 300

See Example 27 in Chapter 5.

(4) Unlike state income tax refunds, which may cause income recognition under thetax benefit rule, Federal refunds carry no such tax consequences.

(5) Interest on municipal bonds ($1,410) is nontaxable, while interest on CDs ($800)and corporate bonds ($360) are included in gross income.

(6) Although qualified dividends are taxed at a preferential rate, they are included aspart of gross income.

(7) Medical expenses—$900 (premiums) + $9,200 (dental) $10,100Less: 7.5% X $92,400 (6,930) $ 3,170

Property taxes 2,800 Sales taxes (receipts available) 1,200 Interest on home mortgage* 2,200 Charitable contributions** 1,300 Total itemized deductions not subject to the 2%-of-AGI limitation $10,670


*Interest on amounts borrowed to purchase or carry tax-exempt municipal bondsis not deductible.

**The political contribution of $200 is nondeductible under the public policylimitation.

(8) Air fare $11,200 Less: nondeductible portion for European trip

(2 weeks/3 weeks X $3,300)* (2,200) $ 9,000 Meals (less 50% cutback) 1,550 Lodging 3,900 Entertainment (less 50% cutback) 1,900 Taxis, limos, rentals, valet ($1,200 + $420) 1,620 Professional expenses 390 Business gifts [10 employees X ($25 + $4)] 290 Car expense under actual expense method** 6,704 Tolls and parking 620 Education expense 240 Total itemized deductions subject to 2% limitation $26,214 Less: 2% of $92,400 (1,848)Total itemized deductions net of 2% limit $24,366

*Foreign travel expense must be allocated between business and personal usebecause neither the 7-day or less exception nor the less than 25% personal useexception applies. Flying business class, rather than coach, is appropriate as norule requires that the cheapest class of transportation be used.

**Car operating expenses—Insurance $1,300 Registration, license, etc. 70 Gasoline and oil 1,500 Tires 300 Repairs 410 Traffic fines (not deductible) -0-

$3,580 Business use percentage X 80% $2,864Depreciation allowed for 2005 is the lesser of—

[$40,000 X 32% (recovery year 2 from Table 8-1,p. 8-27)] X 80% (business use) = $10,240

OR[$4,800 (recovery limitation for year 2 fromp. 8-14) X 80% business use)] = $3,840

Depreciation allowed for 2005 3,840Total car expenses under the actual expense method $6,704

(9) Taxable income $54,164Less specially treated items:

Qualified dividends (940)Taxable income at ordinary rates $53,224

$4,090 + 25%($53,224 – $29,700) $ 9,971Tax on dividends: $940 X 15% 141Total tax liability $10,112


51. Part 1

George’s commissions $49,200Martha’s salary 61,900Interest income (Note 1) 2,100IRA contributions ($3,000 + $3,000) (6,000)George’s employment expenses (Note 2) (16,310)College tuition under § 222 (Note 3) (2,800)Adjusted gross income $88,090Itemized deductions (Notes 4 and 5) (14,493)Personal exemptions ($3,100 X 2) (6,200)Taxable income $67,397

Tax from Tax Table $10,319Less: Withholding and estimated tax ($6,250 + $4,000) (10,250)Net tax payable (or refund due) for 2004 $ 69

Notes

(1) The life insurance proceeds ($100,000) are nontaxable, but the additional $600received from Pyramid Life constitutes interest income and is added to the $1,500interest from the certificate of deposit. The gift received from Martha’s parents isnontaxable.

(2) Because George is a statutory employee, his job-related expenses are deductionsfor AGI. These expenses are summarized below:

Airfare $ 1,820Meals ($2,600 – 50% cutback) 1,300Lodging 1,700Entertainment ($1,400 – 50% cutback) 700Business gifts (30 X $29) 870Auto expense:

Mileage (24,800 X $0.375) $9,300Parking 340Tolls 280 9,920

Total deduction for AGI $16,310

None of the traffic fines of $420 are deductible. The business gift limitation is$25 plus $4 for wrapping and shipping.

George reports the information on the automobile in Part IV of Schedule Cbecause he is using the automatic mileage method. If he were using the actualcost method, he would be required to file Form 4562 (Depreciation andAmortization) because the automobile is listed property.

(3) Only Martha’s tuition of $2,800 falls under § 222. The remainder of her MBAexpenses are deductions from AGI.


(4) Itemized deductions are:

Medical $7,800Less: 7.5% of $88,090 (AGI) (6,607) $ 1,193Real property taxes 3,200Sales taxes (table amount) 1,000Home mortgage interest 7,000Charitable contributions 2,100Miscellaneous expenses (Note 5) -0-Total $14,493

(5) Miscellaneous itemized deductions subject to the 2%-of-AGI floor are calculatedbelow:

Tax return preparation fee $ 300MBA expenses (other than tuition):

Books and supplies $360Bus fare 120 480

Entertainment: ($68 + $74) – 50% cutback 71Professional dues and trade journals ($140 + $220) 360Total $1,211Less: 2% of $88,090 (AGI) (1,762)Deductible amount $ -0-

Not allowed are Martha’s meals of $190 while on campus (she is not in travelstatus) and the lunch she bought to entertain her boss.

See the tax return solution beginning on page 9-21 of the Solutions Manual.

Part 2

a. Only the second alternative would be included in 2004 gross income. The $9,000in dividend income yields a tax of $1,350 ($9,000 X 15%). (Note: qualifieddividend income is subject to a maximum tax rate of 15% for a taxpayer in the25% or above bracket.)

The cash flow would be as follows:

First SecondAlternative Alternative

Income $6,750 $9,000Less: Increase in tax -0- (1,350)Net cash flow $6,750 $7,650

b. The stock investment produces a larger after-tax cash flow of $900 ($7,650 –$6,750) than the municipal bonds.


c. Willis, Hoffman, Maloney, and Raabe, CPAs5191 Natorp Boulevard

Mason, OH 45040

April 1, 2005

Mr. and Mrs. George Jordan321 Oak StreetLincoln, NV 89553

Dear Mr. and Mrs. Jordan:

As per your request, I analyzed two investment alternatives for the $150,000 youreceived as gifts and life insurance proceeds during 2004. These alternativeswere:

1. An investment in municipal bonds yielding 4.5% interest.2. An investment in common stock paying an annual cash dividend of 6%.

The stock investment not only produces a greater yield ($9,000 as opposed to$6,750), but also it results in a higher after-tax cash flow.

Part of the reason for this result is due to the special tax treatment qualifieddividend income now receives. For someone in your tax bracket, dividends aretaxed at a maximum rate of 15%. Consequently, after income taxes areconsidered, the $9,000 of dividend income is reduced to $7,650. The resultexceeds the interest income from the municipal bond investment ($6,750) by$900!

If I can be of further assistance, please call me.

Sincerely,

Agnes Wright, CPAPartner


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