This action might not be possible to undo. Are you sure you want to continue?
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 expenses would be reported on Form 2106 and transferred to Schedule A. Joan’s expenses are deductions 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 Each stylist should pay a set rental for the use of the facility. Except for controlling the hours when the salon will be open, Bernard should allow each stylist to determine his or her own working hours. Each stylist should handle customer appointment and billing functions. 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 public health or safety, Bernard should exercise no control over the clientele of his stylists. p. 9-3 Alexis can claim the mileage from her home to the client locations. The mileage to and from the university qualifies as an education expense. p. 9-15 and Examples 7 and 27 In terms of income derived, the newspaper column he writes predominates. Since the column is written at home, this would be considered his tax home. In this sense, the trips to the university can be regarded as going to a second job. Consequently, the use of his car for this purpose should be deductible. pp. 9-5, 9-8, and Example 5 From the facts given, it appears that Emma has never claimed any deduction for the business use of the auto. If she has already filed for year 2003, an amended return claiming the deduction is appropriate. Due to an absence of records, Emma cannot use the operating cost method of determining the deduction. Consequently, the automatic mileage method should be chosen. Emma can prove the miles driven and the percentage of business use. pp. 9-6 and 9-7 Tyler’s deductible expenses include transportation and meals and lodging for the entire trip. Expenses attributable to the Cub’s game and the museum trips are personal and are not deductible. Because the trip is solely for business and business was conducted on Friday and Monday, the weekend living expenses are regarded as business expenses. p. 9-10 and Examples 10 and 20 The main issue to be resolved is the location of Dr. Werner’s tax home. Presuming his salary 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 or testifies while out of town. p. 9-8 Expenses incurred during a temporary assignment will be treated as if the taxpayer is in travel 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 assignment exceeds one year, it is not temporary. p. 9-8 and Examples 10 and 11 a. b. A taxpayer is never away from home if his or her job is the tax home. Such would be the case of the itinerant worker or trucker who lives where they work. If the taxpayer is never away from home, then all living expenses, such as meals and lodging, become personal and are nondeductible.
Deductions: Employee and Self-Employed-Related Expenses c.
The key to being away from home for tax purposes is the duplication of living expenses. For example, the truck driver who otherwise sleeps at home will be duplicating 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 are not. Although she is employed by the clinic, the content of the seminar probably is not relevant enough to her job assignment. Contrast Examples 16 and 17. p. 9-9 If obtaining the education does not qualify as a deduction, related travel expenses are not allowed. Thus, none of these expenses are deductible. p. 9-9 and Example 18 Travel days count as business days. The weekend counts as business days if the prior Friday and subsequent Monday are business days. The same holds true for a legal holiday. By utilizing these guidelines, Marge can enhance her leisure time while maximizing her deductions. p. 9-10 Quincy did not satisfy the 39-week time requirement. So he has two choices. First, he may increase his income for 2006 by the amount of moving expenses deducted on the 2005 tax return. Second, he can file an amended return for 2005 and recompute his tax after deleting the moving expenses deduction. p. 9-12 First, storage expenses qualify for the deduction for expatriates. Second, the time test does not apply when the expatriate returns to the U.S. to retire. Global Tax Issues on p. 9-13. a. Nondeductible expenses would include those that are not job related (e.g., an accountant’s expenses incurred in obtaining a law degree) or those involved in acquiring a basic skill (e.g., cost to an accountant of taking a review course for the CPA exam). pp. 9-13 and 9-14 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 and 9-16 All other education expenses (i.e., those not disallowed in part a. or included in part b. above) are treated as deductions from AGI. pp. 9-15 and 9-28 One of the advantages of § 222 is that the education involved need not be job related. As a deduction for AGI results, the 2%-of-AGI limitation is not applicable. The AGI limitation and the related partial or complete phaseout of the deduction depends on the year involved and the filing status of the taxpayer. Section 222 is not available when married taxpayers file separate returns.
c. 16. a. b. c. d.
p. 9-16 and Table 9-1 17. Because business entertainment involves an element of pleasure, such entertainment should not be completely deductible.
2006 Comprehensive Volume/Solutions The original scapegoat was the “three-martini lunch.” The cutback adjustment does not preclude any deduction, but merely reduces the amount that can be deducted. The cutback adjustment is further reduced for taxpayers whose employment is regulated by the U.S. Department of Transportation. This group is unlikely to use business meals for pleasurable purposes.
p. 9-17 18. a. b. a. d. The employee is subject to the 50% cutback adjustment. p. 9-17 and Example 29 The employer is subject to the 50% cutback adjustment. p. 9-17 and Example 29 Neither is subject to the cutback adjustment. The award is compensation to the employee and is fully deductible by the employer. p. 9-18 and Example 31 No one is subject to the cutback adjustment. The subsidized eating facility provision represents one of the exceptions to the cutback adjustment rule. p. 918 and Example 32 Employer paid recreational activities are not subject to the cutback adjustment. p. 9-18 De minimis fringe benefits are not subject to the cutback adjustment. p. 9-18 and Example 33
e. f. 19.
The membership dues to the club are not deductible nor are any of the expenses relating to personal use deductible. The business lunches qualify if properly substantiated. The expenses for the golfing activities may be difficult to deduct in view of Madison’s lack of participation. Like the Christmas party, however, the expenses could qualify if preceded or followed by a bona fide business discussion (or presentation). Neither the golf course nor the Christmas party can be regarded as a clear business setting. pp. 9-19, 9-20, and Example 36 Since the tickets were purchased at the last minute, a premium was probably paid. Only the cost of regular tickets (as measured by their face value) is deductible. Any such deduction is subject to the 50% cutback rule. If the entertainment is of the “associated with” variety, attendance at the game must be preceded or followed by a bona fide business discussion. In addition, a partner or an employee of the law firm must be present during the game. p. 9-20 and Example 37
An employee who claims the standard deduction cannot benefit from an office in the home deduction since it is an itemized deduction. A self-employed taxpayer, however, can benefit since a deduction for AGI now is involved. The office must be used exclusively for business. Otherwise the home office is not a qualified home office. Excess expenses can be carried over to future years.
Deductions: Employee and Self-Employed-Related Expenses 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 supplies provision) as deductions for AGI. The balance of $750 is a deduction from AGI and will be subject to the 2%-of-AGI floor. Further, the $750 will not be available if Myrna chooses the standard deduction and does not itemize. p. 9-23 and Example 40 Since this seems to be Trent’s first job, his job search expenses would not qualify for deduction. His moving expenses, however, should qualify as deductions for AGI. In this regard, 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, and 9-23 a. Under a traditional IRA, a contribution is deductible, income accumulates taxdeferred, and distributions are fully taxed. Under a Roth IRA, no deduction is allowed for the contribution, income accumulates tax-free, and distributions are not subject to tax. A traditional IRA and Keogh (H.R. 10) plans follow the same pattern of a deduction followed by a deferral of income tax. IRAs, however, generally arise in an employment setting (i.e., taxpayer is an employee); whereas Keoghs are available to those who are self-employed.
p. 9-24 25. No deduction will be allowed unless the credit card receipts also reflect the business purpose of the expense and the business relationship of Nicholas to the person entertained. p. 9-25 a. b. c. The reimbursements and expenses are omitted from the return. 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. All reimbursements are reported as additional wages (gross income) and the expenses (except moving) are deductible from AGI subject to the 2% of AGI floor. Both Form 2106-EZ (Unreimbursed Employee Expenses) and Schedule A are used. If, however, the employee makes use of the standard deduction, he or she is in the unfortunate position of having to report the reimbursements in gross income 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 of absence from her employer. As long as any such leave is not unduly prolonged, she will still be regarded as being in a trade or business for purposes of claiming the education expense deduction as an itemized deduction. She will not be deemed as having acquired a new trade or business—a graduate degree in tax merely maintains or improves existing skills of an attorney. Note that under § 222 (deduction for qualified tuition and related expenses), Olivia does not have to be concerned about the leave being temporary.
2006 Comprehensive Volume/Solutions 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
It would be unwise for Kim to choose the $48,000 option due to the tax consequences involved. This option makes her subject to the 50% cutback adjustment for business meals and entertainment. But even the portion of these expenses allowable as deductions may not benefit Kim unless she is in a position to itemize her deductions (i.e., forgo the standard 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 the 50% cutback adjustment. pp. 9-17, 9-30, and 9-32
The first major tax problem Jeff is apt to encounter is the inability to deduct his moving expenses. 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 a physician, chances are good that Jeff would have little difficulty obtaining work in the medical field. Keep in mind that it is full-time employment that is required; the income level of such employment is immaterial. pp. 9-12, 9-31, and Example 45 a. If the trip is more than 100 miles from home and includes an overnight stay, a deduction for AGI is allowed. The deduction is limited to the maximum Federal per diem rate applicable to the geographical area involved. Tax in the News on p. 9-29 Deduction from AGI and subject to the 2%-of-AGI floor. p. 9-22 Deduction from AGI and subject to the 2%-of-AGI floor. As the taxpayer is not an elementary or secondary school teacher, the school supplies provision of $250 does not apply. Example 40 Nondeductible, as the IRS maintains that acquiring a law degree or taking the bar exam is qualifying for a new trade or business. p. 9-15 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 Nondeductible, as not directly related to the taxpayer’s trade or business (i.e., dentistry). Example 13 Safety clothing, if related to the job, is deductible. Since the taxpayer is selfemployed, 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 deduction allowed is determined by the distance between the two jobs. The fact that Marlon might return home before going to the second job is immaterial. p. 9-5 and Example 5
Deductions: Employee and Self-Employed-Related Expenses b. 32. 33.
Since Marlon is not in travel status or business entertainment is not involved, the cost of meals is a nondeductible personal expense. p. 9-7
$2,916. 240 days X [(10 miles + 8 miles + 12 miles) X $0.405 (automatic mileage rate for 2005)]. pp. 9-5, 9-6, and Example 6 a. Nelson’s adjusted basis is determined as follows: Cost of automobile Less depreciation (under automatic mileage method): 2003 (15,000 miles X 90% X 16 cents) 2004 (20,000 miles X 90% X 16 cents) 2005 (18,000 miles X 90% X 17 cents) Adjusted basis of auto on 1/1/06 pp. 9-6, 9-7, and Example 9 b. Cost of automobile Less depreciation (allowed under actual operating cost method—see below*) Adjusted basis of auto on 1/1/06 $38,000 (9,819) $28,181 $38,000 (2,160) (2,880) (2,754) $30,206
*Depreciation allowed is the lesser of the table amount (Table 8-1 on p. 8-27) or the recovery limitation (p. 8-14). Year Table Amount Recovery Limitation $3,060 X 90% = $2,754 $4,900 X 90% = $4,410 $2,950 X 90% = $2,655 Depreciation Allowed $2,754 4,410 2,655 $9,819
2003 $38,000 X 20% X 90% = $6,840 2004 $38,000 X 32% X 90% = $10,944 2005 $38,000 X 19.2% X 90% = $6,566 Total depreciation allowed Example 19 in Chapter 8 34. a.
Travel days count as business days and weekends also count as business days when preceded (i.e., Friday) and followed (i.e., Monday) by business days. For Margaret, Thursday is a personal day. Margaret’s deductible expenses are determined below: Airfare Lodging (6 nights X $150) Meals (5 days X $130) X 50% (cutback adjustment) Total p. 9-10 and Example 20 $2,200 900 325 $3,425
As Margaret was way from home for seven days, all of the airfare is deductible and 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 part a. of this problem. pp. 9-10, 9-11, Examples 22, 23, and Footnote 18
9-10 c. 35. a.
2006 Comprehensive Volume/Solutions Because Margaret is self-employed, a deduction for AGI results. p. 9-3 Graham’s assignment is temporary (not indefinite), so his tax home has not changed. While in Cheyenne, therefore, he is in travel status. The deductible portion of his weekend expenses is limited to $320, the amount he would have spent had he not gone home. The answer will not change and remains at $320 but for a different reason. A deduction is always limited to the amount actually spent.
p. 9-8 and Example 10 36. Although they may be very useful to their family, Mrs. Lord’s activities do not constitute a trade or business. Consequently, her expenses at the conference are not deductible. Alvin’s deductible expenses are as follows: Airfare (one ticket) Lodging Meals ($100 X 3 days) Less: cutback adjustment Registration fee ($520 – $120) Car rental Total p. 9-9 and Examples 13, 14, and 16 37. a. Justin’s trip is treated as being 100% for business. Weekends and holidays are business days when preceded and followed by business days. Travel days are business days and (though not mentioned in the text) this should include days when travel is not possible (e.g., equipment failure, weather delays). Yes, as this causes Saturday, Sunday, and Monday to be nonbusiness days. Under the assumptions in part a., all of the airfare would be deductible. This is also the case regarding part b. because of the 7-days-or-less exception. Under the exception, the day of departure is not counted. Consequently, Justin’s trip lasted from Friday to Thursday, or seven days. $ 520 660 150 400 240 $1,970
p. 9-10 and Footnote 18 38. a. Thirteen days. Since travel days count as business, and weekends count as business when preceding and succeeding days are business days, all of her absence is regarded as business. If Monica does not satisfy the 7-day or less-than-25% tests, then part of her transportation cost is not deductible. Monica cannot satisfy the 7-day test because she was away from home for more than 7 days. Under the less-than-25% test and not counting partial days, she could have vacationed for three more days assuming the days did not interfere with the preceding and succeeding days provision.
p. 9-10 and Example 23
Deductions: Employee and Self-Employed-Related Expenses 39. a.
The job search expenses are not included in the moving expense category but are deductible as miscellaneous itemized deductions. As such, they are classified as deductions 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 move are 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 Lodging during move Mileage (6,600 miles X $0.15) Total deduction $6,000 620 990 $7,610
It appears that accounting and human resources are different trades or businesses. If so, the job search expenses become nondeductible. The change in job descriptions does not, however, affect the allowance of the moving expense deduction.
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 that the AGI limitations of § 222 are not exceeded ($65,000 for an unmarried return and $130,000 for a joint return). As Garth spent $4,300 on tuition, the § 222 deduction for AGI is limited to $4,000. Presuming $4,000 is claimed under § 222 [see part (a.) above], the deduction from AGI is as follows: Tuition ($4,300 – $4,000) Books and course materials Lodging Meals ($1,600 X 50% cutback adjustment) Laundry and dry cleaning Campus parking Auto mileage ($1,500 miles X $.405) Total deduction from AGI pp. 9-15, 9-16, and Examples 27 and 28 41. a. b. c. $4,000. The education does not have to be job related. $1,900. A second category of AGI (more than $65,000 and up to $80,000) for years 2004 and 2005. However, only the amount spent for tuition qualifies. Zero, as to a., because pursuing a law degree is treated as qualifying for a new trade or business. As to b., the $200 not allowed for books qualifies as the education is job related. $ 300 650 1,200 800 220 300 608 $4,078
pp. 9-14 to 9-16 42. a. Calvin must include the travel allowance of $12,000 ($1,000 X 12 months) in gross income. He may claim the following as deductions from AGI.
2006 Comprehensive Volume/Solutions Lodging Meals Less: cutback adjustment (30% X $12,480)* $13,600 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 the road for 44 weeks out of the year. This may mean that he is not away from a tax home (i.e., expenses are not duplicated). If this is the case, he is not in travel status. 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) Food and beverages Total entertainment expenses Less: 50% cutback adjustment Total deduction b. $1,400 450 $1,850 (925) $ 925
No. The deduction is determined by the seats available and not those occupied.
p. 9-20 and Example 37 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. The deduction for the gifts to Darlene is limited to $27 ($25 + $2 for gift wrapping is allowed). Subject to the cutback adjustment, the lunch also is deductible. p. 9-20 a. The office in home expenses are $3,500, calculated as follows: Real property taxes (20% X $4,000) Interest on home mortgage (20% X $5,000) Operating expense of home (20% X $1,000) Allocable depreciation $ 800 1,000 200 1,500 $3,500
When combined with other expenses of the business ($3,200), the total of $6,700 exceeds the income from the business by $1,200 ($6,700 – $5,500). Thus, the depreciation allowed is limited to $300 ($1,500 – $1,200), making the deductible office in the home expense $2,300. The nondeductible $1,200 can be carried forward to future years. b. Since Brittany is self-employed as to her financial planner business, all of these transactions 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 be completed.
Deductions: Employee and Self-Employed-Related Expenses
The remainder of the property taxes of $3,200 (80% X $4,000) and mortgage interest expense of $4,000 (80% X $5,000) not involved in the home office will qualify as itemized deductions (deductions from AGI) and can be claimed on Schedule 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 the reimbursement 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 and entertainment and 64%, or $6,400, applies to the other employee expenses. The deductions for AGI and from AGI are reported on Form 2106 in the following manner: Other than Meals and Entertainment $3,400 5,200 900 $9,500 (6,400) $3,100 $3,100 Meals and Entertainment
Lodging Transportation Professional dues and subscriptions Meals ($3,200) and entertainment ($2,200) Total expenses Less: reimbursement (deductible for AGI) Unreimbursed portion Less: cutback adjustment Unreimbursed deduction from AGI
$5,400 $5,400 (3,600) $1,800 (900) $ 900
The totals from Form 2106 are reported on Schedule A, then reduced by 2% of AGI: Total unreimbursed employee expenses ($3,100 + $900) Less: 2% of $94,000 AGI Total deduction from AGI p. 9-27 and Example 43 47. Cole must make an allocation to determine the appropriate portion of the reimbursement that 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 meals and entertainment and $10,050 (67% X $15,000) pertains to the other employee expenses. The deductions for AGI and from AGI are reported in the following manner: $4,000 (1,880) $2,120
2006 Comprehensive Volume/Solutions Other than Meals and Entertainment $ 9,200 5,300 $14,500 (10,050) $ 4,450 $ 4,450
Airfare Lodging Meals Entertainment Total business expenses Less: reimbursement (deductible for AGI) Unreimbursed portion Less: cutback adjustment Unreimbursed deduction from AGI
Meals and Entertainment $4,100 3,100 $7,200 (4,950) $2,250 (1,125) $1,125
The totals from Form 2106 are reported on Schedule A and are reduced by 2% of AGI as follows: Total unreimbursed employee expenses ($4,450 + $1,125) Less: 2% of $98,000 (AGI) Total deduction from AGI p. 9-27 and Example 43 48. As the employer did not identify what the reimbursement was for, Audry must allocate it between the items that are and are not subject to the cutback adjustment. The percentage applicable to the cutback portion is determined as follows: $5,000($2,800 meals + $2,200 entertainment) = 33 1/3% $15,000 (total expenses) Thus, $1,500 (33 1/3% X $4,500) of the reimbursement applies to meals and entertainment while the balance of $3,000 ($4,500 – $1,500) relates to the other employee expenses. Audry’s AGI is: $59,000 (salary) + $1,600 (interest income) – $2,000 (long-term capital loss) = $58,600. The deductions for and from AGI are determined as follows: Other than Meals and Entertainment $ 5,500 4,200 300 $10,000 (3,000) $ 7,000 $ 7,000 Meals and Entertainment $5,575 1,960 $3,615
Transportation Lodging Professional dues and subscriptions Meals and entertainment ($2,800 + $2,200) Total employee expenses Less: reimbursement (treated as deduction for AGI) Unreimbursed expenses Less: cutback adjustment Unreimbursed deductions from AGI
$5,000 $5,000 (1,500) $3,500 (1,750) $1,750
Deductions: Employee and Self-Employed-Related Expenses These items are reported on Schedule A and are reduced by 2% of AGI as follows: Total unreimbursed employee expenses ($7,000 + 1,750) Less: 2% of $58,600 Total employee deductions from AGI allowed p. 9-27 and Example 43 49. a. The Pitt’s AGI for 2005 is computed as follows: Salaries ($51,750 + $48,000) Contributions to traditional IRAs Short-term capital gain AGI b. $99,750 (8,000) 3,000 $94,750
$8,750 (1,172) $7,578
Itemized deductions subject to the 2%-of-AGI limitation are determined as follows: Union dues (Note 1) Safety clothing Professional dues and subscriptions Refreshments for school picnic (Note 2) Correspondence study course (Note 3) Less: 2% X $94,750 (AGI) Deductible portion Add: other itemized deductions Total deductions from AGI $ 1,200 500 400 200 320 $ 2,620 (1,895) $ 725 13,100 $13,825
Notes (1) (2) (3) It is presumed that the Pitts are cash basis taxpayers. Thus, the union dues are deductible in the year paid. Eva’s participation in the cost of the school picnic is related to her job as a teacher. Considering the composition of Eva’s classes (i.e., sixth grade), the correspondence study course is job related, as it would improve her teaching effectiveness.
p. 9-28 and Example 44 CUMULATIVE PROBLEMS 50. Salary Performance bonus (Note 1) Travel and entertainment allowance (Note 2) Employee discount (Note 3) Other income (Note 4): Interest income (Note 5) Dividends (Note 6) $70,000 -024,000 300 1,160 940
2006 Comprehensive Volume/Solutions Contribution to IRA Adjusted gross income Personal exemption Itemized deductions: Not subject to 2% limitation (Note 7) Subject to 2% limitation (Note 8) Taxable income Tax liability (Note 9) Less: Estimated tax payments Net tax payable (or refund due) for 2005 Notes (1) (2) 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. The allowance Brenda receives is income and cannot be offset against her expenses. Because she does not account to her employer, all employment-related expenses are classified as deductions from AGI and will be subject to the 2% limitation. Pursuant to § 132(c)(1), qualified employee discounts are exclusions from gross income. But the exclusion cannot exceed the equivalent of the gross profit percentage. In Brenda’s case, this means an exclusion of $600 and income of $300, determined as follows: Retail price of clothing Less: gross profit (20%) Nontaxable discounted price allowed Cost to Brenda [$3,000 – (30% X $3,000)] Taxable discount See Example 27 in Chapter 5. (4) (5) (6) (7) Unlike state income tax refunds, which may cause income recognition under the tax benefit rule, Federal refunds carry no such tax consequences. Interest on municipal bonds ($1,410) is nontaxable, while interest on CDs ($800) and corporate bonds ($360) are included in gross income. Although qualified dividends are taxed at a preferential rate, they are included as part of gross income. Medical expenses— $900 (premiums) + $9,200 (dental) $10,100 Less: 7.5% X $92,400 (6,930) Property taxes Sales taxes (receipts available) Interest on home mortgage* Charitable contributions** Total itemized deductions not subject to the 2%-of-AGI limitation $3,000 (600) $2,400 2,100 $ 300 (4,000) $92,400 (3,200) $10,670 24,366 (35,036) $54,164 $10,112 (11,000) ($ 888)
$ 3,170 2,800 1,200 2,200 1,300 $10,670
Deductions: Employee and Self-Employed-Related Expenses
*Interest on amounts borrowed to purchase or carry tax-exempt municipal bonds is not deductible. **The political contribution of $200 is nondeductible under the public policy limitation. (8) Air fare Less: nondeductible portion for European trip (2 weeks/3 weeks X $3,300)* Meals (less 50% cutback) Lodging Entertainment (less 50% cutback) Taxis, limos, rentals, valet ($1,200 + $420) Professional expenses Business gifts [10 employees X ($25 + $4)] Car expense under actual expense method** Tolls and parking Education expense Total itemized deductions subject to 2% limitation Less: 2% of $92,400 Total itemized deductions net of 2% limit $11,200 (2,200) $ 9,000 1,550 3,900 1,900 1,620 390 290 6,704 620 240 $26,214 (1,848) $24,366
*Foreign travel expense must be allocated between business and personal use because neither the 7-day or less exception nor the less than 25% personal use exception applies. Flying business class, rather than coach, is appropriate as no rule requires that the cheapest class of transportation be used. **Car operating expenses— Insurance Registration, license, etc. Gasoline and oil Tires Repairs Traffic fines (not deductible) $1,300 70 1,500 300 410 -0$3,580 X 80%
Business use percentage Depreciation 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 from p. 8-14) X 80% business use)] = $3,840 Depreciation allowed for 2005 Total car expenses under the actual expense method (9) Taxable income Less specially treated items: Qualified dividends Taxable income at ordinary rates $4,090 + 25%($53,224 – $29,700) Tax on dividends: $940 X 15% Total tax liability
3,840 $6,704 $54,164 (940) $53,224 $ 9,971 141 $10,112
9-18 51. Part 1
2006 Comprehensive Volume/Solutions
George’s commissions Martha’s salary Interest income (Note 1) IRA contributions ($3,000 + $3,000) George’s employment expenses (Note 2) College tuition under § 222 (Note 3) Adjusted gross income Itemized deductions (Notes 4 and 5) Personal exemptions ($3,100 X 2) Taxable income Tax from Tax Table Less: Withholding and estimated tax ($6,250 + $4,000) Net tax payable (or refund due) for 2004 Notes (1)
$49,200 61,900 2,100 (6,000) (16,310) (2,800) $88,090 (14,493) (6,200) $67,397 $10,319 (10,250) $ 69
The life insurance proceeds ($100,000) are nontaxable, but the additional $600 received from Pyramid Life constitutes interest income and is added to the $1,500 interest from the certificate of deposit. The gift received from Martha’s parents is nontaxable. Because George is a statutory employee, his job-related expenses are deductions for AGI. These expenses are summarized below: Airfare Meals ($2,600 – 50% cutback) Lodging Entertainment ($1,400 – 50% cutback) Business gifts (30 X $29) Auto expense: Mileage (24,800 X $0.375) Parking Tolls Total deduction for AGI $ 1,820 1,300 1,700 700 870 $9,300 340 280
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 C because he is using the automatic mileage method. If he were using the actual cost method, he would be required to file Form 4562 (Depreciation and Amortization) because the automobile is listed property. (3) Only Martha’s tuition of $2,800 falls under § 222. The remainder of her MBA expenses are deductions from AGI.
Deductions: Employee and Self-Employed-Related Expenses (4) Itemized deductions are: Medical Less: 7.5% of $88,090 (AGI) Real property taxes Sales taxes (table amount) Home mortgage interest Charitable contributions Miscellaneous expenses (Note 5) Total (5) $7,800 (6,607)
$ 1,193 3,200 1,000 7,000 2,100 -0$14,493
Miscellaneous itemized deductions subject to the 2%-of-AGI floor are calculated below: Tax return preparation fee MBA expenses (other than tuition): Books and supplies $360 Bus fare 120 Entertainment: ($68 + $74) – 50% cutback Professional dues and trade journals ($140 + $220) Total Less: 2% of $88,090 (AGI) Deductible amount $ 300 480 71 360 $1,211 (1,762) $ -0-
Not allowed are Martha’s meals of $190 while on campus (she is not in travel status) 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 $9,000 in dividend income yields a tax of $1,350 ($9,000 X 15%). (Note: qualified dividend income is subject to a maximum tax rate of 15% for a taxpayer in the 25% or above bracket.) The cash flow would be as follows: First Alternative $6,750 -0$6,750 Second Alternative $9,000 (1,350) $7,650
Income Less: Increase in tax Net cash flow b.
The stock investment produces a larger after-tax cash flow of $900 ($7,650 – $6,750) than the municipal bonds.
2006 Comprehensive Volume/Solutions Willis, Hoffman, Maloney, and Raabe, CPAs 5191 Natorp Boulevard Mason, OH 45040 April 1, 2005 Mr. and Mrs. George Jordan 321 Oak Street Lincoln, NV 89553 Dear Mr. and Mrs. Jordan: As per your request, I analyzed two investment alternatives for the $150,000 you received as gifts and life insurance proceeds during 2004. These alternatives were: 1. 2. An investment in municipal bonds yielding 4.5% interest. 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 qualified dividend income now receives. For someone in your tax bracket, dividends are taxed at a maximum rate of 15%. Consequently, after income taxes are considered, the $9,000 of dividend income is reduced to $7,650. The result exceeds 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, CPA Partner
Deductions: Employee and Self-Employed-Related Expenses 51.
9-22 51. continued
2006 Comprehensive Volume/Solutions
Deductions: Employee and Self-Employed-Related Expenses 51. continued
9-24 51. continued
2006 Comprehensive Volume/Solutions
Deductions: Employee and Self-Employed-Related Expenses 51. continued
9-26 51. continued
2006 Comprehensive Volume/Solutions
Deductions: Employee and Self-Employed-Related Expenses 51. continued