TXX 5761 Taxation of Individuals Assignments

TXX 5761 Taxation of Individuals Assignments ASSIGNMENT #1 – Chapter 3 3: Which of the following items are inclusions in gross income? a. During the year, stock the taxpayer purchased as an investment doubled in value. (NO TAX CONSEQUENCES) b. Amount an off-duty motorcycle police officer received for escorting a funeral procession. (TAXABLE PAYMENTS FOR SERVICES RENDERED) c. While his mother was in the hospital, the taxpayer sold her jewelry and gave the money to his girlfriend. d. Child support payments received. (NO TAX CONSEQUENCES) e. A damage deposit the taxpayer recovered when he vacated the apartment he had rented. (NONTAXABLE RETURN OF CAPITAL) f. Interest received by the taxpayer on an investment in general purpose bonds issued by IBM. g. Amounts received by the taxpayer, a baseball “Hall of Famer,” for autographing sports equipment (e.g. balls, and gloves). (SAME AS B) h. Tips received by a bartender from patrons. (Taxpayer is paid a regular salary by the cocktail lounge that employs him). i. Taxpayer sells his Super Bowl tickets for three times what he paid for them. j. Taxpayer receives a new BMW from his grandmother when he passes the CPA exam. (MAY HAVE GIFT TAX CONSEQUNECES TO GRANDMOTHER BUT IS NONTAXABLE TO THE TAXPAYER). Pages 3-4 and Exhibit 3.2 4: Which of the following items are exclusions from gross income? a. Alimony payments received. b. Damages award received by the taxpayer for personal physical injury – none were for punitive damages. c. A new golf cart won in a church raffle. d. Amount collected on a loan previously made to a college friend. (presuming no interest is charged) e. Insurance proceeds paid to the taxpayer on the death of her uncle – she was the designated beneficiary under the policy. f. Interest income on City of Chicago bonds. g. Jury duty fees. h. Stolen funds the taxpayer had collected for a local food bank drive. i. Reward paid by the IRS for information provided that led to the conviction of the taxpayer’s former employer for tax evasion. j. An envelope containing $8,000 found (and unclaimed) by the taxpayer in a bus station. Exhibits 3.1 and 3.2 5: To save on U.S. income taxes, Lucas (a U.S. citizen and resident of Vermont) invests in foreign stocks and bonds. Is Lucas correct in his approach? Explain Lucas is not correct in his approach because one cannot escape paying taxes. If the investment is a prudent investment then it is acceptable but the intention to invest it to avoid paying taxes is unacceptable. This is unethical and cannot be accepted in any form. He being a resident of Vermont should disclose his investment details to the state of his residence. Whatever income we earn, we need to pay taxes on it. Investment if made in certain securities have to be disclosed and so being a citizen he has to disclose the investment and pay taxes on the same. Global Tax Issues on page 3-6 6: One class of deductions is variously described as deductions for AGI, above the line deductions and page 1 deductions. Explain the meaning of the various designations. A “deduction for” is one that can be claimed in arriving at AGI. Since AGI is the bottom line of page 1 of Form 1040, a “deduction for” is an “above the line” deduction or a “page 1” deduction. Page 3-5 7: In late 2013, the Polk’s come to you for tax advice. They are considering selling some stock investments for a loss and making a contribution to a traditional IRA. In reviewing their situation, you note that they have large medical expenses and a casualty loss, neither of which is covered by insurance. What advice would you give the Polk’s? The sale of the stock investment will result in a capital loss. The capital loss will offset any capital gain, and any excess (of up to $3,000) can be applied against ordinary income to arrive at AGI. The contribution to the traditional IRA is a deduction for AGI. Thus, both the capital loss and the IRA contribution reduce AGI. By reducing AGI, the Polk’s will increase their allowable medical and casualty deductions. [The medical deduction is the excess over 10% (7.5% if age 65 or over) of AGI in 2013, while the casualty loss is the excess over 10% of AGI.] Page 3-6 and Examples 3 and 4 8: In choosing between the standard deductions and itemizing deductions from AGI, what effect, if any, does each of the following have? a. The age of the taxpayer(s). The age of the taxpayer would favor the standard deduction choice if it brought into play the additional standard deduction (age 65 or older)/ b. The health (i.e., physical condition) of the taxpayer. If the taxpayer is blind, an additional standard deduction is available. c. Whether taxpayers rent or own their residence. If the taxpayer is still making house payments, the interest deduction may make itemizing more attractive. d. Taxpayer’s filing status (e.g., single, married, filing jointly). Because the amount of the standard deduction varies depending on filing status, this factor is highly relevant to the decision. e. Whether married taxpayers decide to file separate returns. If married persons file separate returns, the returns must be consistent in the choice made. Thus if one spouse itemizes the other spouse must also itemize. f. The taxpayer’s uninsured personal residence was recently destroyed by fire. Because a large casualty loss seems probable, this increases the advantage to be gained by itemizing. g. The number of personal dependency exemptions the taxpayer can claim. Personal and dependency exemptions have no effect on whether a taxpayer itemizes or chooses the standard deduction option. Page 3-9 to 3-11 and 3-37 10: David is age, 78, is a widower, and is being claimed as a dependent by his son. How does this situation affect the following? a. David’s own individual filing requirements. The filing requirements for persons being claimed as dependents by others are more complex than those applicable to regular taxpayers. They depend on whether the dependent has only earned income, only unearned income, or both earned and unearned income, and the amount of gross income. These rules are summarized on page 3-21 and 3-22 of text b. David’s personal exemption. Dependents are not allowed to claim a personal exemption. Example 12 c. The standard deduction allowed to David. In 2013, the basic standard deduction is the greater of $1,000 or earned income plus $350. The total basic standard deduction allowed, however, cannot exceed $6,100 (the 2013 standard deduction for single taxpayers). Page 3-11 d. The availability of any additional standard deduction. The additional standard deduction of $1,500 is allowed in full. Example 10 11: Sam and Abby are dependents of their parents, and each has income of $2,100 for the year. Sam’s standard deduction for the year is $1,000 while Abby’s is $2, 450. As their income is the same, what causes the difference in the amount of the standard deduction? Sam’s $2,100 is unearned income. Thus, he is allowed the minimum standard deduction of $1,000. Abby’s $2,100 is earned income; so she is allowed a $2,450 [$2,100 (earned income for the year) + 350] standard deduction. Page 3-11 14: Heather, age 12, lives in the same household with her mother, grandmother and uncle. a. Who can qualify for the dependency exemption? Heather is a qualifying child to all three parties. b. Who takes preference? As the parent, the mother takes precedence. If the mother waives, the exemption goes to whoever has the highest AGI as between the grandmother and the uncle. Table 3.3 16: Isabella, Emma, and Jacob share equally in the support of their parents. Jacob tells his sisters to split the dependency exemptions between the two of them. Explain what Jacob means? Under a multiple support agreement, either Isabella, Emma or Jacob can claim either (or both) of their parents as dependents. Jacob is suggesting that his sisters share the exemptions. Page 3-16 and 3-17 18: Mario, who is single, is a U.S. Citizen and resident. He provides almost all of the support of his parents and two aunts, who are citizens and residents of Guatemala. Mario’s parents and aunts are seriously considering moving to and becoming residents of Mexico. Would such a move have any impact on Mario? Why or Why not? Mario should encourage his parents and two aunts to make the move to Mexico. As residents of Mexico, they can be claimed by Mario as dependents. Currently, they do not meet any of the exceptions to the citizenship or residency test for dependents. Page 3-18 22: Comment on the availability of head-of-household filing status for 2013 in each of the following independent situations. a. Taxpayer lives alone but maintains the household of his parents. In July 2013, the parents use their savings to purchase a Lexus automobile for $62,000. If the taxpayer meets the support test, the taxpayer can claim head of household filing status as at least one of the parents must be his dependent. This seems unlikely, however, since their purchase of an auto is part of their support. Thus, the taxpayer must have contributed at least more than $62,000 toward total support. b. Taxpayer maintains a home in which she and her dependent father lives. The father enters a nursing facility for treatment for a mental disorder. Is the stay in nursing home temporary or permanent? If the father can be expected to return to taxpayer’s home, she qualifies for head of household filing status. c. Taxpayer, a single parent, maintains a home in which she and her unmarried son live. The son, age 18, earns $5,000 from a part-time job. Head of household filing status is available since the son is a dependent under the qualifying child category. d. Assume the same facts as in ©, except that the son is age 19, and 18. Head of household filing status is not available. Due to the age test, the son is not a qualifying child. (It is assumed that the son is not disabled or a full-time student.) Due to the gross income test, the son does not satisfy the requirements of a qualifying relative. e. Taxpayer is married and maintains a household in which he and his dependent stepson lives. Normally, a married taxpayer cannot use head of household filing status. If, however, the taxpayer qualifies as an abandoned spouse, this filing status is appropriate. f. Taxpayer lives alone but maintains the household where her dependent daughter lives. Head of household filing status is not available. The daughter is not a member of taxpayer’s household. g. Taxpayer maintains a household that includes an unrelated friend who qualifies as his dependent. Head of household status is not available because the friend, although a dependent, does not meet the relationship test. Page 3-27 and 3-28 25: In connection with the application of the kiddie tax, comment on the following: a. The child has only earned income. The kiddie tax does not apply to earned income. b. The child has a modest amount of unearned income. The kiddie tax does not apply unless unearned income exceeds $2,000. c. The child is age 20, not a student, and not disabled. The kiddie tax will not apply. The age coverage is under 19 or a full-time student under age 24. d. The child is married. The kiddie tax does not apply if the child is married and files a joint return. e. Effect of the parental election. If the parental election is made, the child need not file a return. f. The result when parental election is made and the married parents file separate returns. For married parents filing separate returns, the parent with the greater taxable income is the applicable parent. Page 3-32 – 3-34 26: During the year, Hernando has the following transactions: a. Gain on the sale of stock held as an investment for 10 months. b. Gain on the sale of land held as an investment for 4 years. c. Gain on the sale of a houseboat owned for 2 years and used for family vacations. d. Loss on the sale of a reconditioned motorcycle owned for 3 years and used for recreational purposes. How should Hernando treat these transactions for income tax purpose? Gain on the sale of the stock is a short-term capital gain and is taxed as ordinary income rates. The gain on the sale of the land and houseboat should be combined. As long-term capital gain, the total is subject to tax at preferential rates – 15% or 0%. The loss is personal and, therefore, nondeductible. Page 3-34 to 3-36 29: Compute the taxable income for 2013 in each of the following independent situations: a. Drew and Meg, ages 40 and 41, respectively, are married and file a joint return. In addition to four dependent children, they have AGI of $65,000 and itemized deductions of $15,000. AGI $65,000 Less: Itemized deductions (15,000) Personal and dependency exemptions (6 x $3,900) (23,400) Taxable income $26,600 b. Sybil, age 40, is single and supports her dependent parents who live with her, as well as her grandfather who is in a nursing home. She has AGI of $80,000 and itemized deductions of $8,000. AGI $80,000 Less: Standard deduction (head of household) (8,950) Personal and dependency exemptions (4 × $3,900) (15,600) Taxable income $55,450 c. Scott, age 49, is a surviving spouse. His household includes two unmarried stepsons who qualify as his dependents. He has AGI of $75,000 and itemized of $10,100. AGI $75,000 Less: Standard deduction (surviving spouse) (12,200) Personal and dependency exemptions (3 × $3,900 (11,700) Taxable income $51,100 d. Amelia, age 33, is an abandoned spouse who maintains a household for her three dependent children. She has AGI of $58,000 and itemized deductions of $9,100. AGI $58,000 Less: Itemized deductions (9,100) Personal and dependency exemptions (4 × $3,900) (15,600) Taxable income $33,300 e. Dale, age 42, is divorced but maintains the home in which he and his daughter, Jill, live. Jill is single and qualifies as Dale’s dependent. Dale has AGI of $64,000 and itemized deductions of $9,900. AGI $64,000 Less: Itemized deductions (9,900) Personal and dependency exemptions (2 × $3,900) (7,800) Taxable income $46,300 Page 3-10 and Table 3.1 30: Compute the taxable income for 2013 for Emily on the basis of the following information. Her filing status is single. Salary $85,000 Interest income from bonds issued by Xerox 1,100 Alimony payments received 6,000 Contributions to traditional IRA 5,500 Gift from parents 25,000 Short-term capital gain from stock investment 2,000 Amount lost in football office pool (sports gambling is against the law where Emily lives) 500 Number of potential dependents (two cousins, who live in Canada) ? Age 40 Salary $85,000 Interest on bonds 1,100 Alimony received 6,000 Capital gain 2,000 IRA contribution (5,000) AGI $88,600 Standard deduction (6,100) Personal and dependency exemptions (1 x $3,900) (3,900) Taxable income $78,600 The alimony payments and bond interest are taxable. The gift is nontaxable exclusion. The $2,000 of the capital gain is taxable. Gambling losses are not deductible. Cousins do not meet the relationship test. Page 3-15, 3-35, Figure 3.1, Exhibits 3.1 and 3.2, and Table 3.1 32: Determine the amount of the standard deduction allowed for 2013 in the following independent situations. In each case, assume that the taxpayer is claimed as another person’s dependent. a. Curtis, age 18, has income as follows: $700 interest from a certificate of deposit and $6,000 from repairing cars. $6,100. Although $6,000 (earned income) + $350 = $6.350, the amount allowed cannot exceed that available in 2013 for single taxpayers. b. Mattie, age 18, has income as follows: $600 cash dividends from a stock investment and $4,700 from handling a paper route. $5,050. $4,700 (earned income + $350. c. Mel, age 16, has income as follows: $800 interest on a bank savings account and $700 for painting a neighbor’s fence. $1,050. The grater of $1,000 or $700 (earned income) + $350. d. Lucy, age 15, has income as follows: $400 cash dividends from a stock investment and $500 from grooming pets. $1,000 the greater of $1,000 or $500 (earned income) + $350. e. Sarah, age 67 and a widow, has income as follows: $500 from a bank savings account and $3,200 from babysitting. $5,050. $3,200 (earned income) + $350 + $1,500 (additional standard deduction). Page 3.11, Tables 3.1 and 3.2, and Examples 8 to 11 34: For tax year 2012, determine the number of personal and dependency exemption in each of the following independent situations: a. Leo and Amanda (ages 48 and 46, respectively) are husband and wife and furnish more than 50% of the support of their two children. Elton (age 18) and Trista (age 24). During the year, Elton earns $4,500 providing transportation for elderly persons with disabilities, and Trista receives a $5,000 scholarship for tuition at the law school she attends. Four. Two personal and two dependency exemptions. Elton is a qualifying child, so his gross income does not matter. Trista is not a qualifying child – although a fulltime student, she is not under age 24. However, Trista fits under the qualifying relative category. She passes the gross income test because the tuition portion of a scholarship is nontaxable. b. Audry (age 45) was divorced this year. She maintains a household in which she, her exhusband, Clint, and his mother, Olive, live and furnishes more than 50% of their support. Olive is age 91 and blind. Two. One personal and one dependency exemption. Clint cannot qualify as a member of Audry’s household in the year of the divorce. Olive meets the relationship test. c. Crystal, age 45, furnishes more than 50% of the support of her married son, Andy (age 18), and his wife, Paige (age 19), who live with her. During the year, Andy earned $8,000 from a part-time job. All parties live in Iowa (a common law estate). Three. One personal and one dependency exemption. As Andy is a qualified child, he is not subject to the gross income test. Paige meets the gross income requirements of a qualifying relative. d. Assume the same facts as in ( c ), except that all parties live in Washington (a community property state). Two. One personal and one dependency exemption. Andy as a qualifying child, is still immune from the gross income test. In a community property situation, however, Paige is treated as having $4,000 in gross income. Thus, she does not meet the gross income test and cannot be a qualifying relative. Page 3-12 to 3-16 and 3-38 35: Compute the number of personal and dependency exemptions in each of the following independent situations: a. Reginald, a U.S. citizen and resident, contributes 100% of the support of his parents who are citizens of Canada and live there. Three. The parents qualify as dependents under the Mexico/Canada exception. b. Pablo, a U.S. citizen and resident, contributes 100% of the support of his parents who are citizens of Panama. Pablo’s father is a resident of Panama, and his mother is a legal resident of the United States. Two. Pablo’s father does not qualify as he is a citizen and a resident of Panama while his mother qualifies as a resident of the U.S. c. Gretchen, a U.S. citizen and resident, contributes 100% of the support of her parents, who are U.S. Citizens but residents of Germany. Three. The parents do qualify since they are U.S. citizens. d. Elena is a U.S. citizen and a resident of Italy. Her household includes Carlos, a 4 year old adopted son who is a citizen of Spain. Two. Under a special exception, and adopted child need not be a citizen or a resident of the U.S. (or contiguous country) as long as his or her principal abode is with a U.S. citizen. Page 3-18 and Example 29 38: Sam and Elizabeth Jefferson file a joint return and have three children – all of whom qualify as dependents. If the Jefferson have AGI of $322,000, what is their allowable deduction for personal and dependency exemptions for 2013? Exemption amount (5 x $3,900) $19,500 Step 1: AGI $322,000 Phase-out threshold (300,000) Excess amount $ 22,000 Step 2: $22,000 ÷ $2,500 = 8.8 (rounded up to 9) 9 x 2 = 18% (phase-out percentage) Step 3: Less: $19,500 x 18% (3,510) Step 4: Deduction for personal and dependency exemptions $15,990 Page 3-19 39: Wesley and Myrtle (ages 90 and 88, respectively) live in an assisted care facility and for 2012 and 2013 received their support from the following sources PERCENTAGE OF SUPPORT Social Security benefits 16% Son 20% Niece 29% Cousin 12% Brother 11% Family friend (not related) 12% a. Which persons are eligible to claim the dependency exemptions under a multiple support agreement? Son, niece and brother. The cousin and the family friend do not meet the relationship test. b. Must Wesley and Myrtle be claimed by the same person(s) for both 2012 and 2013? Explain. No. The eligible parties can rotate the exemptions as they choose. c. Who, if anyone, can claim their medical expenses? If the eligible person who is awarded the exemption also pays the medical expenses, then such person can claim them. Examples 27 and 53 40: Taylor, age 18, is claimed as a dependent by her parents. For 2013, she has the following income: $4,000 wages from a summer job, $1,800 interest from a money market account, and $2,000 interest from city of Boston bonds. a. What is Taylor’s taxable income for 2013? Wages $4,000 Money market interest 1,800 Bond interest (City of Boston bond interest is tax-exempt) ---0--- Gross Income $5,800 Less: standard deduction* (4,350) Personal exemption** ---0--- Taxable income $1,450 b. What is Taylor’s tax for 2013? [(Her parents file a joint return and have taxable income of $130,000 (no dividends or capital gains.)] Money Market Interest $ 1,800 Bond interest - 0 – Total unearned income $ 1,800 Minus: $1,000 + $1,000 standard deduction (2,000) Income taxed at parents rate $ ---0--- Income taxed at Taylor’s rate $ 1,450 Total tax ($1,450 x 10%) *** $ 145 *A dependent’s standard deduction is limited to the greater of $1,000 or the sum of his or her earned income plus $350. **A dependent may not claim a personal exemption on his or her return. ***Since Taylor’s unearned income is not more than $2,000, her tax is determined without using her parents’ rate. Thus, Taylor’s 2012 tax liability is $145 ($1450 taxable income x 10%). Pages 3-11, 3-32, Exhibit 3.1 and Example 10 41: Walter and Nancy provide 60% of the support of their daughter (age 18) and son-in-law (age 22). The son-in-law (John) is a full-time student at a local university, while the daughter (Irene) holds various part-time jobs from which she earns $11,000. Walter and Nancy engage you to prepare their tax return for 2013. During a meeting with them in late March 2014, you learn that John and Irene have filed a joint return. What tax advice would you give based on the following assumptions: a. All parties live in Louisiana (a community property state). Regardless of where the parties reside, it is essential that the damage of the joint return be undone. The joint return test applies to both the qualifying child and qualifying relative categories of dependency exemptions. The situation can be rectified by filing separate returns on or before April 15, 2014. In Louisiana, one-half of the daughter’s income, or $5,500 (50% x $11000), is assigned to John. Being a qualifying child, the daughter can be claimed as a dependent. John, however, is subject to the gross income test contained in the qualifying relative category. Since $5,500 exceeds $3,900, John cannot be claimed as a dependent. b. All parties live in New Jersey (a common law state). As noted in part a., the joint return problem needs to be resolved. In New Jersey, none of the daughter’s income is earned by John. Consequently, John now meets the gross income test of a qualifying relative. The daughter also can be claimed as a dependent since there is no gross income test applicable to the qualifying child category. Examples 49, 51 and 52 42: Charlotte (age 40) is a surviving spouse and provides all of the support of her four minor children who live with her. She also maintains the household in which her parents live and furnished 60% of their support. Besides interest on City of Miami bonds in the amount of $5,500, Charlotte’s father received $2,400 from a part-time job. Charlotte has a salary of $80,000, a short-term capital loss of $2,000, a cash prize of $4,000 from a church raffle, and itemized deductions of $10, 500. Using the Tax Rate Schedules, compute the 2013 tax liability for Charlotte. Salary $ 80,000 Short-term capital loss (2,000) Cash prize 4,000 AGI $ 82,000 Less: Personal and dependency exemptions (7 x $3900) (27,300) Standard deduction (12,200) Taxable income $ 42,500 Tax on $42,500 using surviving spouse rate schedule: $1,785 ÷ 15% ($42,500 - $17,850) = $5,482.50. The father does not fail the gross income test because tax-exempt income is not counted. Pages 3-9, 3-10, 3-29, 3-36, Figure 3.1, Table 3.1 and Concept Summary 3.1 46: In each of the following independent situations, determine Winston’s filing status for 2013. Winston is not married. a. Winston lives alone, but he maintains a household in which his parents live. The mother qualifies as Winston’s dependent, but the father does not. Winston qualifies for head of household filing status. As long as one parent is his dependent, this is enough. b. Winston lives alone but maintains a household in which his married daughter, Karin, lives. Both Karin and her husband (Winston’s son-in-law) qualify as Winston’s dependents. Winston must use single filing status. Except in the case of parents, head of household status requires that the dependent be a member of taxpayer’s household. c. Winston maintains a household in which he and a family friend, Ward, live. Ward qualifies as Winston’s dependent. The dependent must meet the relationship test. Therefore, Winston must use single filing status. d. Winston maintains a household in which he and his mother-in-law live. Winston’s wife died in 2012. Winston can qualify for head of household if the mother-in-law is his dependent. He does not meet the requirements of a surviving spouse since a mother-in-law is not a child. e. Same as (d), except that Winston’s wife disappeared (i.e., she did not die) in 2011. Since Winston is still married, he cannot use head of household filing status. (He does not satisfy the requirements of an abandoned spouse – a mother-in-law is not a child). Consequently, Winston must use married filing separately filing status. Pages 3-26 to 3-28 and Examples 32 to 34 47: Christopher died in 2011 and is survived by his wife, Chloe, and their 18 year old son, Dylan, Chloe is the executor of Christopher’s estate and maintains the household in which she and Dylan live. All of their support is furnished by Chloe while Dylan saves his earnings. Dylan’s status for is as follows: Year Earnings Student Status 2011 $ 5,000 Yes 2012 7,000 No 2013 6,000 Yes What is Chloe’s filing status for: a. 2011? For year 2011, Chloe should file a joint return. Since she is the executor of Christopher’s estate, she can consent on his behalf to file jointly. Being under 19 years of age, her son is a qualifying child. Thus, she can claim three exemptions – two personal and one dependency. b. 2012? For year 2012, Chloe will have to file as single. She is not a surviving spouse because she cannot claim Dylan as a dependent. Dylan is not a qualifying child (due to the age test) and is not a qualifying relative (due to the gross income test). c. 2013? For year 2013, Chloe is a surviving spouse. She can claim Dylan as a dependent. Dylan is a qualifying child – although not under age 19, he is a fulltime student. As a qualifying child, he is not subject to the gross income test. Examples 31 and Concept Summary 3.1 48: Nadia died in 2012 and is survived by her husband, Jerold (age 44); her married son, Travis (age 22); and her daughter-in-law, Macy (age 18). Jerold is the executor of his wife’s estate. He maintains the household where he, Travis, and Macy live and furnishes all of their support. During 2012 and 2013, Travis is a full-time student, while Macy earns $7,000 each year from a part-time job. Travis and Macy do not file jointly during either year. What is Jerold’s filing status for 2012 and 2013 if all parties reside in: a. Idaho (a community property state)? For 2012, Jerold can file a joint return. As executor of Nadia’s estate, he can issue a consent on her behalf. For 2013, Jerold can qualify as a surviving spouse. Travis is a qualifying child due to his student status, and Macy is a qualifying relative – her gross income of $3,500 (50% x $7000) meets the gross income test. Thus, Jerold has three exemptions – one personal and two dependencies. b. Kansas (a common law state)? The answer as to filing status does not change: For 2012 – joint return and for 2013 – surviving spouse. Kansas is a common law state, so all of the $7,000 Macy earns is assigned to her. Travis is a qualifying child. Macy will not be a dependent under the qualifying relative category because of the gross income test. Thus, Jerold will have two exemptions. Page 3-26 and Concept Summary 3.1 49: Paige, age 17, is claimed as a dependent on her parents’ 2013 return on which they report taxable income of $120,000 (no qualified dividends or capital gains). Paige earned $3,900 pet sitting and $4,000 in interest on a savings account. What are Paige’s taxable income and tax liability for 2013? Unearned income $ 4,000 Minus: $1,000 base amount + $1,000 standard deduction (2,000) Unearned income taxed at parents’ rate $ 2,000 Paige’s parents are in the 25% bracket, so her unearned income would generate $500 of tax (25% x 2000). Computation of Paige’s taxable income and tax: Earned Income $ 3,900 Interest income 4,000 Gross Income $ 7,900 Less: Personal exemption (- 0 - ) Less: Standard deduction (4,250) [Greater if $1000 or $3900 (earned income) + $350] Taxable income $ 3,650 Less: Unearned income taxed at parents’ rate (2,000) Income taxed at Paige’s rate $ 1,650 Paige’s tax rate x 10% Tax at Paige’s rate $ 165 Paige’s total tax: $500 (unearned income taxed at parents rate) + $165 (taxed at Paige’s rate) = $665. Example 41 50: Terri, age 16, is claimed as a dependent on her parents’ 2013 return. During the year, Terri earned $5,000 in interest income and $3,000 from part-time jobs. a. What is Terri’s taxable income? Earned Income $ 3,000 Interest income 5,000 Gross income and AGI $ 8,000 Less: Standard deduction (3,350) [greater of $1000 or $3000 (earned income) + $350] Taxable income $ 4,650 b. How much of Terri’s income is taxed at her rate? At her parents’ rate? Taxed at parents’ rate: Unearned income $ 5,000 Less: $1000 + $1000 (2,000) Neat unearned income (taxed at parents’ rate) $ 3,000 Taxed at Terri’s rate: Taxable income $ 4,650 Less: amount taxed at parents’ rate (3,000) Taxed at Terri’s rate $ 1,650 c. Can the parental election be made? Why or why not? The parental election cannot be made as Terri’s income is not solely from interest and dividends. Page 3-32 and Example 41 52: During the year, Chester had the following transactions involving capital assets: Gain on the sale of an arrowhead collection (acquired as an investment at different times but all pieces have been held for more than one year) $6,000 Loss on the sale of IBM Corporation stock (purchased 11 months ago as an investment) ($4,000) Gain on the sale of a city lot (acquired 5 years ago as an investment) $2,000 a. If Chester is in the 33% bracket, how much income tax results? Chester has a collectible gain of $6,000, a LTCG (long-term capital gain) of $2,000, and a STCL (short-term capital loss) of $4,000. Offsetting the STCL against the collectible gain leaves: $2,000 collectible gain ($6000 – 4000) and $2,000 LTCG. The tax liability is $860 [($2000 x 28%) + ($2000 x 15%)]. b. $300 [($2000 x 15%) + ($2000 x 0%)]. Pages 3-34 and 3-35 53: Each year, Tom and Cindy Bates normally have itemized deductions of $10,000, including a $4,000 pledge payment to their church. Upon the advice of a friend, they do the following: in early January 2013, they pay their pledge for 2012; during 2013, they pay the pledge for 2013; and in late December 2013, they prepay their pledge for 2014. a. Explain what the Bates are trying to accomplish. By concentrating the payment of three years of charitable contributions (2012, 2013, and 2014) into one year, this will allow the Bates to itemize their deductions from AGI in 2013. Otherwise their itemized deductions (normally $10,000) are of no benefit, as they do not exceed the standard deduction ($11,900 for 2012 and $12,200 for 2013). b. What will be the tax saving if their marginal tax bracket is 25% for all three years? (Assume that the standard deduction amounts for 2013 and 2014 are the same). Presuming the $10,000 of normal itemized deductions already includes one year of church pledge payments, the additional payment of $8,000 ($4,000 for 2012 and $4,000 for 2014) yields itemized deductions of $18,000 ($10000 + $8000) for 2013. This exceeds the standard deduction that would have been claimed by $5,800 ($18000 - $12200). Therefore, the tax savings by concentrating the charitable contributions becomes $1,450 (25% x $5800). The same tax that would have been paid will result for 2012 and 2014 as the standard deduction is claimed for each of these years. c. Write a letter to Tom and Cindy Bates (8212 Bridle Court, Reston, VA 20194) summarizing your analysis. Spillman and Byington, CPA’s 1822 Barker Cypress Road Houston, TX 77084 January 13, 2014 Mr. & Mrs. Tom Bates 8212 Bridle Court Reston, VA 20192 Dear Mr. & Mrs. Bates: In response to your inquiry regarding the Federal income tax consequences of consolidating your charitable contributions for 2012, 2013, and 2014 into a single year (2013), here is a brief summary of the outcomes:  As individual taxpayers are presumed to be on a cash basis, all cash expenditures during a year will be evaluated in determining deductibility. In this case, combining the three $4,000 contributions into a single year makes sense from an income tax perspective.  By combining all three payments in 2013, you will be able to itemize your deductions in that year, while using the standard deduction amount in 2012 and 2014.  These $8,000 of additional contributions in 2013 (the $4,000 payments for 2012 and 2014) will mean that you will have total itemized deductions of $18,000 (which exceeds the 2013 married filing jointly standard deduction times your marginal tax rate of 25%).  Your tax savings by consolidating these contributions in 2013 will be $1,450 (the $5,800 of total itemized deductions in excess of the standard deduction times your marginal tax rate of 25%). If I can be of further assistance to you in this matter, please do not hesitate to contact me. Sincerely, Tanya Byington Tax Partner Page 3-37 Assignment #1 – Chapter 4 27: Andy recently completed medical school and is beginning his medical practice. Most of his patients are covered by health insurance with a co-pay requirement (e.g., the patient pays $10, and the insurance company is billed for the remainder). It takes approximately two months to collect from the health insurance plan. What advice can you provide Andy regarding the selection of a tax accounting method? Andy should use the cash method of accounting so that the income from services billed to the insurance company can be deferred until the income is collected. Under the cash method, the amounts billed to the insurance companies will be continuously deferred until the year following his final year of practice. That is, with the cash method of accounting as compared to the accrual method, Andy will enjoy a deferral of two months of billings to insurance companies. Andy’s marginal tax rate may be lower in the first year of practice than in subsequent years. Thus, accelerating income through the use of the accrual method would have some benefit. But the benefit of the lower rates probably would not equal the benefit of deferral. Pages 4-8 to 4-10 28: A taxpayer is considering three alternative investments of $10,000. Assume that the taxpayer is in the 28% marginal tax bracket for ordinary income and 15% for qualifying capital gains in all tax years. The selected investment will be liquidated at the end of five years. The alternatives are:  A taxable corporate bond yielding 5% before tax, and the interest can be reinvested at 5% before tax.  A series EE bond that will have a maturity value of $12,200 (a 4% before-tax rate of return).  Land that will increase in value. The gain on the land will be classified and taxed as a long-term capital gain. The income from the bonds is taxed as ordinary income. How much must the land increase in value to yield a greater after-tax return than either of the bonds? Given: Compound amount of $1 and compound value of annuity payments at the end of five years: Interest Rate $1 Compounded for 5 years $1 Annuity Compounded for 5 years 5% $1.28 $5.53 4% 1.22 5.42 3.6% 1.19 5.37 The taxable bond and reinvested earnings will accumulate at an after-tax rate of 3.6% [(1 - .28) x .05] to equal $11,900 at the end of 5 years [($10,000 x 1.19) = $11,900]. Note: (1) Calculate Net after Tax Interest Rate: 1 - .28 (applicable tax rate) x .05 (interest rate on bond) (2) Calculate net after Tax Income after 5 years (the “yield” or return on investment of $10,000 in the Bond where the 5% annual income is reinvested at the same 5% interest/investment return – “compounded”) Yield = [1.036]⁵ = 1.1934 1.1934 x $10,000 = $11,934 Table Factor: based on after tax interest rate of 3.6% = 1.19 rounded The income from the Series EE Bond will not be taxed until maturity in five years, and the after-tax value will be $11,584 [$12,200 paid at maturity MINUS .28 (applicable tax rate) x the interest (ie., OID) ($12,200 - $10,000) = $2,200] = $616 income tax payable. $12,200 - $616 tax on OID = $11,584 Table Factor: based on an internal interest rate of 4% --------- $10,000 invested X1.22 = $12,200. Thus, the after-tax proceeds from the land must exceed $11,900. Because the gain on the land will be taxed as a long-term capital gain, the sales proceeds less 15% of the appreciation must exceed $11,900. $10,000 (investment) + (1 - .15) (net after tax amount) times (“X” (the appreciated value at end of 5 years needed to beat $11,900) - $10,000 original investment) = $11,900 Solve for “X” $10,000 + .85X – 85,000 [i.e. $10,000 x .85] = $11,900 .85X = $11,900 + 8500 - $10,000 = $10,400 X = $10,400 / .85 = $12,235 Thus, the land must increase in value by at least $2,235 to yield a greater after-tax return than the investment in either of the bonds. Pages 4-4, to 4-6, 4-36 and 4-37 29: Determine the taxpayer’s gross income for tax purposes in each of the following situations: a. Deb, a cash basis taxpayer, traded a corporate bond with accrued interest of $300 for corporate stock with a fair market value of $12,000 at the time of the exchange. Deb’s cost of the bond was $10,000. The value of the stock had decreased to $11,000 by the end of the year. Deb must recognize $300 interest income and $1,700 gain ($11,700 - $10,000) when she exchanged the bond for stock. Of the value of the corporate stock she received, $300 was for accrued interest. The remaining $11,700 was in exchange for the bond whose cost was $10,000. The fact that the stock decreased in value after the exchange is not relevant because she still owns the stock and thus has not realized the loss in value. Note: Amount Received $12,000 value of bond Allocate to accrued interest: $300 Balance of Amount Received = $11,700 Cost of Bond Given = $10,000 = $1,700 LTCG (long term capital gain) b. Deb needed $10,000 to make a down payment on her house. She instructed her broker to sell some stock to raise the $10,000. Deb’s cost of the stock was $3,000. Based on her broker’s advice, instead of selling the stock, she borrowed the $10,000 using the stock as collateral for the debt. Deb did not realize income when she borrowed on the property. Her net worth did not increase – assets and liabilities increased by an equal amount. c. Deb’s boss gave her two tickets to the Rabid Rabbits rock concert because she met her sales quota. At the time she received the tickets, each ticket had a face price of $200 and was selling on eBay for $300. On the date of the concert, the tickets were selling for $250 each. Deb and her son attended the concert. Deb must recognize compensation income of $600 ($300 x 2), the fair market value of the tickets at the time she received them. Pages 4-4 to 4-7 30: Determine Amos Watkin’s gross income in each of the following cases: a. In the current year, Amos purchased an automobile for $25,000. As part of the transaction, Amos received $1,500 rebate from the manufacturer. The $1,500 is a reduction in the cost of the automobile and is not income. b. Amos sold his business. In addition to the selling price of the stock, he received $50,000 for a covenant not to compete – an agreement that he will not compete with his former business for five years. The $50,000 payment received under the covenant is included in Amos’s gross income because the payment is an increase in wealth realized. c. Amos owned some land he held as an investment. As a result of a change in the zoning rules, the property increased in value by $20,000. The change in the zoning rules that cause the property to increase in value is economic gain but is not a realized gain for tax purposes. Amos’s wealth increased, but the realization requirement is not satisfied, since he did not receive any additional property nor were any improvements made to his property. Amos will not realize this increase in wealth for tax purposes until he sells the property. Pages 4-5 and 4-10 31: Al is a medical doctor who conducts his practice as a sole proprietor. During 2013, he received cash of $280,000 for medical services. Of the amount collected, $40,000 was for services provided in 2012. At the end of 2013, Al had accounts receivable of $60,000, all for services rendered in 2013. In addition, at the end of the year, Al received $12,000 as an advance payment for a health maintenance organization (HMO) for services to be rendered in 2014. Compute Al’s gross income for 2013: a. Using the cash basis of accounting. Al’s gross income for 2013 on the cash basis is $292,000 ($280,000 + $12,000), which is the amount he actually collected in that year. b. Using the accrual basis of accounting. Al’s gross income computed by the accrual method is as follows: Cash received $ 292,000 Less: Income received but will not be earned until 2014 (12,000) Less: Beginning of the year accounts receivable (40,000) Plus: End of year account receivable 60,000 $ 300,000 c. Advise Al on which method of accounting he should use. Al should use the cash method of accounting so that he will not have to pay income taxes on uncollected accounts receivable. Pages 4-8 to 4-10 and 4-14 32: Selma operates a contractor’s supply store. She maintains her books using the cash method. At the end of the year, her accountant computes her accrual basis income that is used on her tax return. For 2013, Selma had cash receipts of $1.4 million, which included $200,000 collected on accounts receivable from 2012 sales. It also included the proceeds of a $100,000 bank loan. At the end of 2013, she had $250,000 in accounts receivable from customers, all from 2013 sales. a. Compute Selma’s accrual basis gross receipts for 2013. Accrual basis gross receipts Cash received $ 1,400,000 Less: beginning accounts (200,000) Less: bank loan (100,000) Add: ending accounts receivable 250,000 Gross receipts $ 1,350,000 b. Selma paid cash for all of the purchases. The total amount paid for merchandise in 2013 was $1.3 million. At the end of 2012, she had merchandise on hand was $300,000. Compute Selma’s gross income from merchandise sales for 2013. Gross income: Gross receipts $1,350,000 Cost of goods sold: Purchases $1,300,000 Beginning inventory 150,000 Ending inventory (300,000) (1,150,000) Gross income $ 200,000 Pages 4-8 to 4-10 33: Your client is a new partnership, ARP Associates, which is an engineering consulting firm. Generally, ARP bills clients for services at the end of each month. Client billings are about $50,000 each month. On average, it takes 45 days to collect the receivables. ARP’s expenses are primarily for salary and rent. Salaries are paid on the last day of each month, and rent is paid on the first day of each month. The partnership has a line of credit with a bank, which requires monthly financial statements. These must be prepared using the accrual method. ARP’s managing partner, Amanda Sims, has suggested that the firm also use the accrual method for tax purposes and thus reduce accounting fees by $600. Assume that the partners are in the 35% (combined Federal and State) marginal tax bracket. Write a letter to your client explaining why you believe it would be worthwhile for ARP to file its tax return on the cash basis even though its financial statements are prepared on the accrual basis. ARP’s address is 100 James Tower, Denver, CO 80208. Spillman and Byington, CPA’s 1822 Barker Cypress Road Houston, TX 77084 January 13, 2014 Ms. Amanda Sims Managing Partner ARP Associates 100 James Tower Denver, CO 80208 Dear Ms. Sims: I am responding to your suggestion that ARP Associates should change to the accrual method of accounting for tax purposes as a means of reducing fees. Under the accrual method of accounting, receivables must be recognized as income as the services are performed. This is to be contrasted with the cash method of accounting where no income is recognized until payment is received. Each year, under the accrual method, accelerated tax payments would occur so long as the billing and collection pattern remains the same. Therefore, the partners will pay tax on an additional $75,000 in the first year’s income [accrual of billings in first year that would not be collected until second year – one half of November’s billings ($25,000) and all of December’s billings ($50,000)], and those payments will not be recovered until the company ceases its operations. Assuming the partners are in the 35% (combined State and Federal) marginal tax bracket, the deferred taxes under the cash method are $26,250 9(.35 x $75,000). If the partners earn a 2.29% ($600 ÷ $26,250) return, or greater, on the deferred taxes, the additional accounting fees will be recovered. Therefore, I recommend that you continue to use the cash method. Sincerely, Tanya Byington, CPA Tax Partner Pages 4-8 to 4-10 and 4-18 35: Determine the effects of the following on a cash basis taxpayer’s gross income for 2013 and 2014. a. On the morning of December 31, 2013, the taxpayer received a $1,500 check from a customer. The taxpayer did not cash the check until January 3, 2014. The check is a cash equivalent and therefore the $1,500 must be included in the cash basis taxpayer’s 2013 gross income when it was actually received. b. The same as part (a), except the customer asked the taxpayer not to cash the check until January 3, 2014, after the customer’s salary check could be deposited. The check is not a cash equivalent because of the restrictive conditions placed upon it. Therefore, a cash basis taxpayer does not include the $1,500 in gross income until 2014. c. The same as part (a), except the check was not received until after the bank had closed on December 31, 2013. The fact that the bank was closed is not relevant. The check is a cash equivalent and therefore the $1,500 must be included in 2013 gross income. Page 4-9 36: Marlene, a cash basis taxpayer, invests in Series EE U.S. government savings bonds and bank certificates of deposit (CDs). Determine the tax consequences of the following on her 2013 gross income: a. On September 30, 2013. She cashed in Series EE bonds for $10,000. She purchased the bonds in 2003 for $7,090. The yield to maturity on the bonds was 3.5%. The Series EE bonds are not subject t the original issue discount (OID) rules. Therefore, assuming that Marlene did not elect to take the annual increments in value into income each year, her 2013 gross income from the bonds is $2,910 ($10,000 - $7,090). b. On July 1, 2012, she purchased a CD for $10,000. The CD matures on June 30, 2014, and will pay $10,816, thus yielding a 4% annual return. The CD contains $816 ($10,816 - $10,000) of original issue discount (OID) which must be amortized by the effective interest method. Because Marlene owned the CD for 6 months in 2012, she should have recognized $200 ($10,000 x .04 x1/2 year) in 2012. In 2013, Marlene earned 4% on the compounded amount of the investment [.04($10.00 + $200) = $408]. c. On July 1, 2013, she purchased a CD for $10,000. The maturity date on the CD was June 30, 2014, when Marlene would receive $10,300. The CD is issued for a period of one year and therefore the OID rules do not apply. Marlene, as a cash basis taxpayer, is not required to recognize any income until 2014 when the CD matures. Pages 4-12 and 4-13 37: Drake Appliance Company, an accrual basis taxpayer, sells home appliances and service contracts. Determine the effect of each of the following transactions on the company’s 2013 gross income assuming that the company uses any available options to defer its taxes. a. In December, 2012, the company received a $1,200 advance payment from a customer for an appliance that Drake special ordered from the manufacturer. The appliance did not arrive from the manufacturer until January 2013, and Drake immediately delivered it to the customer. The sale was reported in 2013 for financial accounting purposes. The $1,200 is included in the 2013 gross income. The advance payment received in 2012 for goods delivered in 2013 qualifies for deferral because the company satisfied the tax and financial accounting conformity requirement. b. In October 2013, the company sold a 6 month service contract for $240. The company also sold a 36 month service contract for $1,260 in July 2013. For the sale of the 6 month service contract, $120 is included in 2013 gross income [$240 x 3/6 = $120]. The advance payment for services qualifies for proration over the life of the contract because all of the income will be earned by the end of the tax year following the year of receipt. c. On December 31, 2013, the company sold an appliance for $1,200. The company received $500 cash and a note from the customer for $700 and $260 interest, to be paid at the rate of $40 a month for 24 months. Because of the customer’s poor credit record, the fair market value of the note was only $600. The cost of the appliance was $750. The company must include $1,200 in gross receipts and can deduct the cost of the appliance, $750, in arriving at gross income of $450. The fair market value of the note is not relevant for purposes of determining the accrual method taxpayer’s gross income. The interest of $260 will be taxed as it accrues over the 24-month life of the contract. Pages 4-9 and 4-14 38: Freda is a cash basis taxpayer. In 2013, she negotiated her salary for 2014. Her employee offered to pay her $21,000 per month in 2014 for a total of $252,000. Freda countered that she would accept $10,000 each month for 12 months in 2014 and the remaining $132,000 in January 2015. The employer accepted Freda’s terms for 2014 and 2015. a. Did Freda actually or constructively receive $252,000 in 2014? No. Actual receipt applies to the $120,000 ($10,000 x 12 months) she received in 2014. The $132,000 deferred income is not constructively received in 2014 because under the actual contract terms, she did not have the right to receive the income in 2014. The constructive receipt doctrine cannot change actual events to “what might have been done”. b. What could explain Freda’s willingness to spread her salary over a longer period of time? Freda may have expected to be in a lower marginal tax bracket in 2015. She also benefited by not having to pay the tax on the income shifted into 2015 until she filed her 2015 income tax return or made payments on estimated taxes for 2015. c. In December 2014, after Freda earned the right to collect the $132,000 in 2015, the employer offered $133,000 to Freda at that time, rather than $132,000 in January 2015. The employer wanted to make the early payment so as to deduct the expense in 2014. Freda rejected the employer’s offer. Was Freda in constructive receipt of the income in 2014? Explain. Yes. The $132,000 actually received in 2015 was constructively received in 2014 because it was made available to her in that year. Pages 4-8 to 4-12 39: The Bluejay Apartments, a new development, is in the process of structuring its lease agreements. The company would like to set the damage deposits high enough that tenants will keep the apartments in good condition. The company is actually more concerned about damage than about tenants not paying their rent. a. Discuss the tax effects of the following alternatives:  $1,000 damage deposit with no rent prepayment. The $1,000 damage deposit is not taxed in the year of receipt.  $500 damage deposit and $500 rent for the final month of the lease. The damage deposit is not taxable at the time it is collected but the $500 prepaid rent is taxed in the year of receipt.  $1,000 rent for the final two months of the lease and no damage deposit. The $1,000 prepaid rent is taxed in the year of receipt. b. Which option do you recommend? Why? The Bluejay Apartments should use the first option. By doing so, it maximizes deferrals without affecting the cash flows. Pages 4-14 and 4-15 43: In 2013, Alva received dividends on her stocks as follows: Amur Corporation (a French corporation whose stock is traded on an established U.S. Securities market) $ 60,000 Blaze, Inc., a Delaware corporation 40,000 Grape, Inc. a Virginia corporation 22,000 a. Alva purchased the Grape stock three years ago, and she purchased the Amur stock two years ago. She purchases the Blaze stock 18 days before it went ex-dividend and sold it 20 days later at a $5,000 loss. Alva had no other capital gains and losses for the year. She is in the 35% marginal tax bracket. Compute Alva’s tax on her dividend income for 2013. Amur dividends (Note 1) $ 60,000 Blaze dividends (Note 2) 40,000 Grape dividends 22,000 Total dividend income $122,000 Note 1: Even though Amur is a foreign corporation, the dividend is a qualified dividend because its stock is traded on an established U.S. securities market. Note2: The dividend paid by Blaze is not a qualified dividend because the holding period requirement is not satisfied (i.e., must be held more than 60 days during the 121-day period beginning 60 days before the ex-dividend date). Qualified dividends Amur dividend $60,000 Grape dividend 22,000 $82,000 Applicable rate x 15% Tax on qualified dividends $12,300 Non-qualified dividends Blaze dividend $40,000 Applicable rate x 35% Tax on non-qualified dividends $14,000 b. Alva’s daughter, who is 25 and not Alva’s dependent had taxable income of $6,000, which included $1,000 of dividends on Grape, Inc. stock. The daughter had purchased the stock two years ago. Compute the daughter’s tax liability on the dividends. The daughter is in the 10% marginal tax bracket. She has $1,000 of qualified dividends which are eligible for the alternative tax rate of 0% (rather than the usual 15%). So the daughter’s tax liability on the dividends is $0 ($1,000 x 0%). c. Alva can earn 5% before-tax interest on a corporate bond or a 4% dividend on a preferred stock. Assuming that the appreciation in value is the same, which investment produces the greater after-tax income? Alva’s after-tax return on the bond is 3.25% [(1 - .35)(.05)]. Her after-tax return on the stock is 3.4% [(1 - .15)(.04)]. Therefore, the stock yields the greater after-tax return, since any appreciation in value is the same. d. The same as part (c), except that Alva’s daughter is to make the investment. The daughter is in the 10% marginal tax bracket. Therefore, her after-tax return on the bond is 4.5% [(1 - .10)(.05)]. Her after-tax return on the stock is 4.0% [(1 - .00)(.04)]. Therefore, the bond yields the greater after-tax return. Pages 4-16 and 4-17 45: Nell and Kirby are in the process of negotiating their divorce agreement. What should be the tax consequences to Nell and Kirby if the following, considered individually, became part of the agreement? a. In consideration for her one-half interest in their personal residence, Kirby will transfer to Nell stock with a value of $200,000 and $50,000 of cash. Kirby’s cost of the stock was $150,000, and the value of the personal residence is $500,000. They purchased the residence three years ago for $300,000. The transfers of the stock and residence pursuant to the divorce are nontaxable to Nell and Kirby. Nell assumes Kirby’s basis in the stock of $150,000, and Kirby’s basis in the house is $300,000. However, the $50,000 cash paid by Kirby will be alimony unless the agreement specifies that the payment is “not alimony”. b. Nell will receive $1,000 per month for 120 months. If she dies before receiving all 120 payments, the remaining payments will be made to her estate. The cash payments of $1,000 per month do not qualify as alimony because they will not cease upon Nell’s death. The payments are excluded from Nell’s gross income as they are received by her, and Kirby may not deduct the payments (would be a deduction for AGI if the payments had been classified as alimony). c. Nell is to have custody of their 12-year-old son, Bobby. She is to receive $1,200 per month until Bobby (1) dies or (2) attains age 21 (whichever occurs first). After either of these events occurs, Nell will receive only $300 per month for the remainder of her life. The monthly payments of $1,200 are in part child support and in part alimony. The monthly amount that will continue after the occurrence of the contingency related to the child is considered alimony. Therefore, $300 per month is alimony that must be included in Nell’s gross income, and the other $900 received each month is child support. Kirby can deduct the alimony payments of $300 as a deduction for AGI. Pages 4-22 to 4-25 46: Samantha and Harold are in the process of negotiating a divorce. They have tentatively agreed on all of the terms, and Samantha is to pay Harold $240,000 over a three year period. Furthermore, the payments are to be spread over the three years in amounts that will qualify as alimony and minimize alimony recapture. Harold wants to receive as much of the $240,000 as soon as possible because if he dies or remarries within three years, the payments will cease. Which of the following two patterns of payments will result in the least alimony recapture in year 3? Year Option 1: Amount Paid Option 2: Amount Paid 1 $120,000 $100,000 2 60,000 80,000 3 60,000 60,000 Total $240,000 $240,000 Option #2 results in the least alimony recapture, $22,500, as compared to alimony recapture of $45,000 for Option #1. Option #1 The first option will not result in alimony recapture for Year 2 because the year three payment does not decrease by more than $15,000. Applying the formula in the text, the recapture for Year 2 (D) is calculated as follows: D = B – (C + $15,000) = [$60,000 – ($60,000 + $15,000)] = is less than $0; therefore D = $0. However, there is $45,000 alimony recapture from Year 1 (E) E = A – [(B – D + C)/2 + $15,000] = $120,000 – [($60,000 - $0 + $60,000)/2 +$15,000] = $45,000. So total alimony recapture under Option #1 would be $45,000 Option #2 The second option will result in $5,000 alimony recapture from Year 2 and $17,500 recapture from Year 3. D = $80,000 – ($60,000 + $15,000) = $5,000 E = A – [(B – D + C)/2 + $15,000] = $100,000 – [($80,000 - $5,000 + $60,000)/2 +$15,000] = $17,500. Pages 4-22 to 4-25 48: Roy decides to buy a personal residence and goes to the bank for a $150,000 loan. The bank tells him that he can borrow the funds at 4% if his father will guarantee the debt. Roy’s father, Hal, owns a $150,000 CD currently yielding 3.5%. The Federal rate is 3%. Hal agrees to either of the following:  Roy borrows from the bank with Hal’s guarantee to the bank  Cash in the CD (with no penalty) and lend Roy the funds at 2% interest. Hal is in the 33% marginal tax bracket, Roy, whose only source of income is his salary, is in the 15% marginal tax bracket. The interest Roy pays on the mortgage will be deductible by him. Which option will maximize the family’s after-tax wealth? The family’s after-tax cash flow will decrease by less if Roy borrows from Hal rather than the bank. Interest is imputed on the loan from Hal (at 3%) because the interest rate charged by Hal (2%) is less than the Federal rate (3%). With the loan from Hal, all of the interest stays in the family rather than being paid to and received from the bank, Hal’s tax on his interest income decreases and Roy’s tax benefit from deducting the interest decreases by a lesser amount. Borrow from Bank Borrow from Hal Hal’s interest on CD, $x.035= $5,250 Less: tax on the interest income, $5250x.33 (1,733) Hal’s interest on loan to Roy, $x.03=$4500 Less: Hal’s tax on imputed interest =(x.03)x.33 ($1,485) Roy’s bank interest expense, x.04=6000 (6,000) Roy’s tax benefit from deducting interest, 6000x.15 900 Roy’s tax benefit from interest to Hal (x.03)x.15 675 After-tax cash flow to family ($1,583) ($ 810) Pages 4-25 to 4-28 49: Ridge is a generous individual. During the year, he made interest-free loans to various family members when the Federal rate was 3%. What are the tax consequences of the following loans by Ridge? a. On June 30, 2013, Ridge loaned $12,000 to his cousin, Jim, to buy a used truck. Jim’s only source of income was his wages on various construction jobs during the year. The imputed interest amount for six months is $180 ($12,000 x .03 x .5). However, the imputed interest rules do not apply because the loan was less than $100,000, and Jim does not have any investment income. b. On August 1, 2013, Ridge loaned $8,000 to his niece, Sonja. The loan was to enable her to pay her college tuition. Sonja had $1,200 interest income from CDs her parents had given her. The imputed interest rules do not apply because this gift loan was for less than $10,000, and it was not used to purchase income producing property. c. On September 1, 2013, Ridge loaned $25,000 to his brother, Al, to start a business. Al had $220 of dividends and interest for the year. The imputed interest for four months is $250 ($25,000 x .03 x 4/12). Because the amount of the loan exceeds $10,000 and the borrower had net investment income that is less than the imputed interest amount, the imputed interest is limited to an amount equal to Al’s net investment income of $220. This amount would be reported as interest income for Ridge and as interest expense for Al. However, since this amount does not exceed $1,000, no interest is imputed. d. On September 30, 2013, Ridge loaned $150,000 to his mother so that she could enter a nursing home. His mother’s only income was $9,000 of Social Security benefits and $500 of interest income. The imputed amount for three months is $1,125 ($150,000 x .03 x 3/12). This amount is reported as interest income by Ridge and as interest expense by his mother. The investment income limitation does not apply to this loan because the laon exceeded $100,000. Pages 4-12 and 4-25 to 4-28 50: Indicate whether the imputed interest rules should apply in the following situations. Assume that all of the loans were made at the beginning of the tax year unless otherwise indicated. a. Mike loaned his sister $90,000 to buy a new home. Mike did not charge interest on the loan. The Federal rate was 5%. Mike’s sister had $900 of investment income for the year. This loan is a gift loan between individuals that is eligible for the $100,000 exception. Although Mike’s sister has $900 of investment income, interest is not imputed under this exception if the borrower’s net investment income is not greater than