CHAPTER 6 DEDUCTIONS AND LOSSES: IN GENERAL SOLUTIONS TO PROBLEM MATERIALS

Question/ Problem 1 " & ' ) * + 0 12 11 1" 1& 1' 1) 1* 1+ 110 "2 "1 "" "& "' ") "*

Learning Objective LO 1 LO 1 LO 1 LO 1 LO 1 LO 1 LO 1 LO 1 LO 1 LO 1 LO 1 LO " LO " LO " LO " LO & LO & LO & LO & LO & LO & LO & LO & LO & LO & LO &

Topic Allowed income and deductions #eductions for and from A$% #eductions for and from A$% #eductions for and from A$% #eductions for and from A$% #eductions for and from A$% #eductions for and from A$%, deductions disallowance Ordinar. and necessar. re/uirement 1easonable compensation 3usiness versus nonbusiness losses 1eporting procedures 4et!od o5 accounting: cas! basis Prepa.ment provision 5or cas! basis ta6pa.er All events and economic per5ormance tests 1eserves and economic per5ormance test %llegal activities #omestic and 5oreign bribes Legal e6penses %llegal activities Political contributions Lobb.ing e6penditures E6cessive e6ecutive compensation %nvestigation o5 a business 7obb./business 8acation !ome rental: classi5ication 8acation !ome rental: deduction o5 loss 6-1

Status: Present Edition nc!anged pdated nc!anged (ew nc!anged nc!anged pdated (ew nc!anged nc!anged nc!anged nc!anged nc!anged nc!anged nc!anged nc!anged nc!anged nc!anged nc!anged nc!anged (ew (ew (ew (ew (ew nc!anged

Q/P in Prior Edition 1 " & ) * + 0 12 11 1" 1& 1' 1) 1* 1+ 110 "2

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2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua Status: Present Edition nc!anged nc!anged Status: Present Edition nc!anged nc!anged nc!anged nc!anged (ew pdated (ew nc!anged (ew nc!anged nc!anged nc!anged nc!anged nc!anged (ew nc!anged nc!anged 4odi5ied nc!anged nc!anged (ew nc!anged nc!anged nc!anged nc!anged nc!anged nc!anged 4odi5ied nc!anged nc!anged 4odi5ied Q/P in Prior Edition "0 &2 &1 &" &' &* &&0 '2 '1 '" '' ') '* '+ ')2 )1 )" )& )' )* )+ ))0 *2 Q/P in Prior Edition "+ "-

Question/ Problem "+ "Question/ Problem "0 &2 &1 &" && &' &) &* &+ &&0 '2 '1 '" '& '' ?') '* '+ ?'?'0 )2 ?)1 ?)" ?)& ?)' )) )* )+ ?))0

Learning Objective LO & LO & Learning Objective LO & LO & LO & LO & LO 1 LO 1 LO 1 LO 1 LO 1 LO " LO " LO " LO & LO & LO & LO &< ' LO & LO & LO & LO & LO & LO & LO & LO & LO 1< & LO 1< &< ' LO &< ' LO &< ' LO & LO & LO &

Topic 8acation !ome rental: e6clusion :onversion o5 a residence to rental propert. Topic Anot!er ta6pa.er=s obligation Personal e6penses versus deductible legal e6penses Losses between related parties Ta6>e6empt income/e6penses #eductions for and from A$% #eductions for and from A$% #eductions for and from A$% 1easonable salaries 3usiness and nonbusiness losses :as! met!od versus accrual met!od :as! basis and prepaid e6penses Economic per5ormance test Legal e6penses and public polic. limitations %llegal business Lobb.ing e6penses and political contributions E6cessive e6ecutive compensation E6cessive e6ecutive compensation %nvestigation o5 a business %nvestigation o5 a business 7obb./business 7obb. losses/business 8acation !ome rental: e6clusion 8acation !ome rental: court=s approac! and %1S=s approac! 8acation !ome rental: primaril. rental use Ta6able income calculation and vacation !ome Anot!er ta6pa.er=s obligations :apital e6penditures and amorti@ation Losses between related parties #eductions between related parties and constructive owners!ip Losses between related parties Ta6>e6empt income/e6penses

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D$du!(i"n& and L"&&$&: In G$n$)a Status: Present Edition (ew pdated 4odi5ied *" *& Q/P in Prior Edition

6>*

Question/ Problem *2 ?*1 ?*"

Learning Objective LO 1< &< '

Topic Anot!er ta6pa.er=s obligations and classi5.ing deductions 5or and 5rom A$% :umulative :umulative

?T!e solution to t!is problem is available on a transparenc. master;

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2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua Status: Present Edition (ew nc!anged nc!anged nc!anged (ew (ew nc!anged nc!anged Q/P in Prior Edition " & ' + -

1esearc! Problem 1 " & ' ) * + -

Topic E6penditures on anot!er=s be!al5 Aines and legal e6penses 8acation !ome treatment 7obb. versus trade or business 7obb. loss #eduction for A$% %nternet activit. %nternet activit.

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D$du!(i"n& and L"&&$&: In G$n$)a CHEC, -IGURES &&; &';a; &';b; &); &*;a; &*;b; A$% reduced b. B'<-)2; A$% is B)2<)22; Select itemi@ed deductions o5 B-<)22; Cit! %1A contribution B)<*22, wit!out %1A contribution B)<'22; 1educe ta6able income o5 T!rus!< %nc; T!rus!=s ta6able income B2 i5 deemed reasonable, c!ildren report B'1<**+ eac!, probabl. most o5 B1")<222 will be classi5ied as unreasonable; #educt B'<222; B)22<222 under cas! met!od; B)')<222 under cas! met!od; B1"2<222; B-)<222; B&<222; %ncrease A$% b. B1)<222; %ncrease A$% b. B1)<222; %ncrease A$% b. B')<-22; B2; Adopt t!e per5ormance>based compensation program; Salar. and bonus B-;1* million, retirement plan contribution B')*<222; B&-<1&"; B)"<222; B)"<222; B2; B&<-1+; Ta6able income B&0<&22; '0;a; '0;b; )2; )1;a; )1;b; )"; )&; )';a; )';b; )';c; ));a; ));b; )*;a; )*;b; )+; (et increase in ta6able income B)<-*2; (et decrease in ta6able income B)<+22; (o impact on A$%; (et rental income B2, itemi@ed deduction B12<))); (et rental income B2, itemi@ed deduction B'<*22; (et rental loss B1"<2)&, deduction B&"); B"&<)2+; B1+<222; B2; :!elsie s!ould give or loan B1<222 to Elisa and :l.de w!o t!en pa. B1<222 to 3o.d; B1+&<222 allocated to listed assets; B"+<222 is eit!er 5or goodwill or covenant not to compete; Loss o5 B"'<222 is not deductible; $ain B*<222, loss B-<222, B2; 1obin ma. deduct B"<-22 in "21& 5or loan 5rom Peter< but can=t deduct B"<-22 5or %sabelle=s loan until "21', %sabelle and Peter !ave interest income o5 B"<-22 eac! in "21'; B2; B1)<222 loss; B2; B1<)22 loss; B')<222 gain; B1+<)22; 1e5und due B*1*; 1e5und due B1<1'";

6>+

&+; &-;a; &-;b; &0; '2; '1; '";a; '";b; '";c; '&; ''; '); '*; '+;a; '+;b; '+;c; '+;d; '-;

)-;a; )-;b; )-;c; )-;d; )-;e; )0; *1; *";

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2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua

DISCUSSION .UESTIONS 1; "; C!ile t!e :ode provides an all>inclusive de5inition o5 income< deductions must be speci5icall. provided 5or in t!e :ode in order to be permitted; p; *>" Aaron would pre5er deductions for A$% because t!e. are allowable in addition to t!e standard deduction; #eductions from A$% are claimed onl. w!en t!e. e6ceed t!e standard deduction and are in lieu t!ereo5; Additionall.< deductions w!ic! reduce A$% ma. increase t!ose itemi@ed deductions w!ic! are subject to A$% 5loors De;g;< medical e6penses E+;)F or 12FG< miscellaneous itemi@ed deductions E"FGH; p; *>& 4ic!ael s!ould contribute t!e ma6imum amount o5 B)<222 5or "21& to !is traditional %1A; Since !is contribution is classi5ied as a deduction for A$%< 4ic!ael also is eligible to taIe t!e standard deduction; p; *>' a; b; c; d; e; 5; (ot deductible; #eduction from A$%; #eduction from A$% Esubject to +;)F or 12F 5loorG; #eduction for A$%; #eduction for A$%; #eduction for A$%;

&;

';

pp; *>&< *>'< and :oncept Summar. *;& ); a; b; c; d; e; 5; #eduction for A$%; (ot deductible; #eduction for A$%; B'22 deduction from A$%; T!e B122 principal pa.ment is not deductible; #eduction for A$%; #eduction from A$%;

pp; *>& to *>) and :oncept Summar. *;& *; %nvestment e6penses associated wit! rental propert. or ro.alt. propert. are deductible for A$%; Ot!er investment e6penses are deductible from A$%; Susan evidentl. !as invested in rental or ro.alt. propert.< w!ereas Larr. !as invested in ot!er investment propert.; p; *>' (anette is eligible to deduct t!e c!aritable contributions o5 B-22 and t!e personal propert. ta6es o5 B"'2 as itemi@ed deductions Edeductions from A$%G; 7owever< since t!e standard deduction 5or "21& o5 B*<122 is greater t!an !er itemi@ed deductions o5 B+')< s!e s!ould claim t!e standard deduction; %n addition< s!e is allowed t!e B"") under t!e teac!er=s supplies provision as a deduction for A$%; pp; *>' and *>)

+;

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T!ree items w!ic! J 1*" speci5icall. e6cludes 5rom classi5ication as a trade or business e6pense are as 5ollows: :!aritable contributions or gi5ts; %llegal bribes and IicIbacIs and certain treble damage pa.ments; Aines and penalties;

p; *>) 0; T!e statutor. language o5 t!e :ode re5ers to reasonableness onl. wit! respect to salaries and ot!er compensation; 7owever< t!e courts !ave !eld t!at 5or an. business e6pense to be ordinar. and necessar.< it must also be reasonable in amount; p; *>* T!e ta6 conse/uences to #ave 5or t!e residence and t!e business portions are di55erent; T!e casualt. loss on t!e residence part must be reduced b. B122 and t!en t!e aggregate o5 all allowable personal use propert. casualt. losses 5or t!e .ear must e6ceed 12F o5 A$%; (o suc! adjustments are re/uired 5or t!e casualt. loss on t!e business portion; p; *>+ 1ental income and e6penses are reported on Sc!edule E ESupplemental %ncome or LossG o5 Aorm 12'2; Aigure *;1 :as! basis ta6pa.ers can deduct an e6pense onl. w!en it !as been paid wit! cas! or ot!er propert.; 3orrowing t!e mone. to pa. t!e e6pense Eor c!arging it on a banI credit cardG constitutes actual pa.ment; 7owever< actual pa.ment does not ensure a current deduction; Aor e6ample< capital e6penditures must be capitali@ed; Subse/uentl.< t!e e6penditure ma. be amorti@ed< depleted< or depreciated; E6cept in certain circumstances< prepaid items cannot be currentl. deducted; p; *>0 1&; a; %t is doubt5ul t!at Aubr. could deduct t!e B*)<222 o5 supplies in "21& because !e was motivated b. ta6 considerations Ei;e;< to manipulate incomeG; See t!e Keller case cited in Aootnote "&; %5 Aubr. boug!t t!e supplies at a discount< !e would be motivated b. business reasons ot!er t!an ta6 reduction; Since t!e supplies would be used wit!in t!e 5ollowing .ear< t!e Zaninovich case indicates t!at Aubr. could deduct t!e supplies; p; *>0 and Aootnote "1

12;

11; 1";

b;

1';

T!e all events test and t!e economic per5ormance test must be met be5ore an accrual basis ta6pa.er can deduct an e6pense; Aor t!e all events test to be satis5ied< E1G all t!e events must !ave occurred to create t!e ta6pa.er=s liabilit.< and E"G t!e amount o5 t!e liabilit. can be determined wit! reasonable accurac.; Once t!ese re/uirements are satis5ied< t!e deduction is permitted onl. i5 economic per5ormance !as occurred; T!e economic per5ormance test is met onl. w!en t!e service< propert.< or use o5 propert. giving rise to t!e liabilit. is actuall. per5ormed 5or< provided to< or used b. t!e ta6pa.er; pp; *>0 and *>12 T!e reason t!e reserve met!od cannot be used 5or ta6 purposes is t!at it does not meet t!e economic per5ormance test; E6ample 1" (o< :lear cannot deduct t!e 5ines because t!e. are pa.ments in violation o5 tari55 laws; p; *>11

1); 1*;

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2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua T!e two issues involved are w!et!er t!e pa.ment s!ould be made and< i5 made< is it deductible; %5 made to t!e representatives o5 a ;S; compan.< it would be a bribe; (ot onl. would it be nondeductible< it could result in criminal c!arges; %5 t!e pa.ment is made to t!e representative o5 t!e 5oreign compan.< more t!an liIel. it would be an accepted trade practice in t!at countr.; %n t!is case< since t!e pa.ment would not violate t!e ;S; Aoreign :orrupt Practices Act o5 10++< it would t!ere5ore be deductible; p; *>11 (o; Legal 5ees incurred in connection wit! a criminal de5ense are deductible onl. i5 t!e crime is associated wit! t!e ta6pa.er=s trade or business or income>producing activit.; Since Stuart does not satis5. t!is re/uirement< t!e attorne.=s 5ee is not deductible; p; *>1" Onl. c;< t!e price paid 5or drugs purc!ased 5or resale; C!et!er t!e business is legal or illegal< cost o5 goods sold is allowed as a reduction 5rom total sales in arriving at gross income 5rom t!e business; T!us< cost o5 goods sold is treated as a negative income item rat!er t!an as a deduction; p; *>1& (o< a deduction is not permitted 5or political contributions; p; *>1' Lobb.ing e6penses generall. are not deductible; T!ere5ore< i5 4elissa pa.s t!e B1<)22 to a pro5essional lobb.ist< t!e pa.ment is not deductible; 7owever< a de minimis e6ception provides t!at in>!ouse lobb.ing e6penditures not e6ceeding B"<222 per .ear can be deducted; T!us< i5 4elissa spends t!e B1<)22 on in>!ouse lobb.ing e6penditures< s!e can deduct t!is amount; (ote t!at i5 t!e in>!ouse e6penditures !ad e6ceeded B"<222< none o5 t!e in>!ouse e6penditures could !ave been deducted; p; *>1' An emplo.er can deduct a ma6imum o5 B1 million annuall. 5or compensation pa.ments to a covered e6ecutive; :overed e6ecutives include t!e c!ie5 e6ecutive o55icer and t!e 5our ot!er most !ig!l. compensated o55icers; T!e provision applies onl. i5 t!e emplo.er is a publicl. !eld corporation; Emplo.ee compensation e6cludes: :ommissions based on individual per5ormance; :ertain per5ormance>based compensation dependent on compan. per5ormance; Pa.ments to ta6>/uali5ied retirement plans; Pa.ments t!at are e6cludible 5rom t!e emplo.ee=s gross income Ee;g;< certain 5ringe bene5itsG;

1-;

10;

"2; "1;

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pp; *>1' and *>1) "&; a; Apparentl. t!e business being investigated b. Paul was a restaurant; 3ecause Paul is alread. in t!e restaurant business< !e can deduct all o5 t!e investigation e6penses o5 B+<222; Evidentl. t!e business being investigated was not a restaurant and Paul did not ac/uire t!e business; :onse/uentl.< !e is not allowed an. deduction 5or t!e e6penses; T!e business being investigated b. Paul in :olumbus was not a restaurant< but Paul did ac/uire t!e business; T!ere5ore< !e can taIe a limited deduction o5 B)<222 and amorti@e t!e balance as start>up costs over a 1-2>mont! period;

b; c;

pp; *>1)< *>1*< and :oncept Summar. *;1

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D$du!(i"n& and L"&&$&: In G$n$)a "'; a; 7arold=s business decreases !is A$% b. B1<0'2; 1evenue Less: #epreciation on car Operating e6penses o5 car 1ent Cages Amorti@ation (et income B"2<222 B&<0*2 &<122 *<222 -<"22 *-2

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E"1<0'2G EB 1<0'2G

T!e decline in t!e value o5 t!e land o5 B)<"22 !as no immediate ta6 conse/uence; b; p; *>1+ "); a; T!e vacation !ome is classi5ied as primaril. personal because it was rented 5or 5ewer t!an 1) da.s during t!e .ear; As Sara! can e6clude t!e B"<)22 o5 rent income< t!e vacation !ome transactions !ave no e55ect on !er A$%; T!e onl. e6penses t!at Sara! can deduct are t!ose s!e normall. would deduct as itemi@ed deductions; T!is includes t!e 5ollowing: 4ortgage interest Propert. ta6 Total B12<222 1<)22 B11<)22 As t!e activit. is a !obb.< 7arold cannot deduct an. loss;

b;

Sara! cannot deduct an. o5 t!e utilities< insurance< and maintenance e6penses or t!e depreciation; (one o5 t!e e6penses are deductible for A$%; p; *>"2 "*; Aor a rental loss on a vacation !ome to be deductible< t!e propert. must be classi5ied as primaril. rental; :onse/uentl.< t!e 5ollowing re/uirements must be satis5ied: t!e residence is rented 5or 1) da.s or more during t!e .ear and is not used 5or personal purposes 5or more t!an t!e greater o5 E1G 1' da.s or E"G 12F o5 t!e rental da.s; Even !ere< !owever< t!e e6penses must be allocated between t!e rental and t!e personal da.s; p; *>"2 %n prior .ears< t!e beac! !ome !as been classi5ied as a rental propert. since t!e personal use Ee6actl. 1' da.sG did not e6ceed t!e greater o5 1' da.s or 12F o5 rental da.s E"22 K 12F L "2 da.sG; T!us< i5 t!e total available deductions e6ceeded t!e rental income< t!e loss could be deducted on Maren and And.=s ta6 return; %5 Sara! is permitted to use t!e beac! !ouse 5or + da.s< t!e total personal use da.s o5 "1 will e6ceed t!e statutor. limit o5 "2 da.s Ei;e;< 12F o5 rental da.s o5 "22G; %n t!is case< t!e deductions are permitted onl. to t!e e6tent o5 t!e rental income; C!at needs to be determined are w!et!er t!e deductions do e6ceed t!e rental income and w!et!er Sara! wants to use it 5or a 5ull + da.s; pp; *>"2 to *>"" 7anI can deduct propert. ta6es and mortgage interest 5rom Nanuar. 1 to 4arc! 1 as an itemi@ed deduction 5rom A$%; T!e !ome was !is personal residence during t!at period; Aor t!e rest o5 t!e .ear< 5rom 4arc! 1 t!roug! #ecember &1< !e can deduct propert. ta6es< mortgage interest< depreciation< and all ot!er e6penses 5or A$% as rental e6penses; T!e O/uali5ied rental periodP re/uirements !ave been met; 7e !as converted !is personal

"+;

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2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua residence into rental propert. and no allocation o5 e6penses need be made< even i5 t!ere is a rental loss; p; *>"&

"0;

a; b; c;

Aor 1a. to deduct t!e interest< !e needs to maIe t!e pa.ment to t!e mortgage compan.; T!us< Ted could give t!e mone. to 1a. so 1a. pa.s t!e mortgage compan.; %5 Ted pa.s t!e mortgage compan. directl.< Ted cannot deduct t!e interest since it is not !is obligation; 1a. would not be permitted t!e deduction since !e did not maIe t!e pa.ment; T!e obligation is t!at o5 1a. and not t!at o5 Ted; T!us< Ted is not permitted to deduct t!e interest even i5 !e maIes t!e pa.ment directl. to t!e mortgage compan.;

E6ample &" &2; Edna can deduct onl. t!ose legal e6penses associated wit! t!e divorce 5or w!ic! t!e origin and c!aracter o5 t!e claim are directl. related to a trade or business< an income>producing activit.< or t!e determination< collection< or re5und o5 a ta6; As personal legal e6penses are not deductible< onl. t!e e6penses relating to t!e items mentioned above /uali5.; pp; *>")< *>"*< and E6ample && T!e ta6 issue is w!et!er Ella will be able to deduct t!e loss on t!e sale o5 t!e stocI; %5 t!e trans5eree is a related part. under J "*+< t!e reali@ed loss is disallowed; Ot!erwise< t!e reali@ed loss is recogni@ed; T!e gi5t to t!e ot!er relative !as no e55ect on t!e sales transaction; Alt!oug! no income ta6 conse/uences result< t!e imposition o5 a Aederal gi5t ta6 s!ould be considered; pp; *>"+ and *>"a; Alt!oug! Narret receives interest pa.ments o5 B&<-22< all o5 t!is amount is e6cluded 5rom !is gross income; %nterest on municipal bonds is ta6>e6empt; b; (one o5 Narret=s interest pa.ments o5 B'<022 on t!e loan can be deducted; T!e proceeds o5 t!e loan were used to purc!ase ta6>e6empt bonds; :onse/uentl.< t!e interest e6pense deduction is disallowed; LiIewise< none o5 t!e principal pa.ments o5 B1<122 can be deducted since t!is is merel. t!e pa.ment o5 a liabilit.; pp; *>"0 and *>&1

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PROBLEMS &&; a; Since t!e e6penses relate to Amos=s ta6 law practice and are paid b. !im< !e can claim t!em in calculating A$%; T!e e6penses reduce !is A$% b. B'<)")< determined as 5ollows: :on5erence registration EB022 Q B022G Airline ticIets EB1<"22 Q B+22G Ta6i 5ares Lodging EB+)2 Q B&22G b; B1<-22 1<022 122 1<2)2 B'<-)2

T!e answer in a; 5or Amos would not c!ange; T!ese e6penses are associated wit! !is business as a ta6 attorne.;

E6ample 1

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D$du!(i"n& and L"&&$&: In G$n$)a &'; a; $ross income: Salar. income (et rent #ividend income #eductions for A$%: Alimon. paid :ontribution to traditional %1A Loss on sale o5 real estate Adjusted gross income b;

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B*2<222 *<222 &<)22 B1"<222 )<222 "<222

B*0<)22

E10<222G B)2<)22

%temi@ed deductions: 4ortgage interest on residence B '<022 Propert. ta6 on residence 1<"22 :ontribution to c!urc! "<122 State income ta6 &22 4edical e6penses DB&<")2 R EB)2<)22 K 12FGH R2R Total itemi@ed deductions B -<)22 Since t!e standard deduction 5or "21& EB*<122G is less t!an #aniel=s itemi@ed deductions EB-<)22G< #aniel s!ould itemi@e !is deductions from A$%; T!e Aederal income ta6 o5 B+<222 is not deductible; pp; *>& to *>) &); $ross income :ontribution to %1A A$% %temi@ed deductions: :!aritable contribution 4edical e6penses DB&<222 R E12F K A$%GH :asualt. loss DEB&<)22 R B122G R E12F K A$%GH Total itemi@ed deductions Cit! %1A :ontribution B12<222 E1<222G B 0<222 B1<222 "<122 "<)22 B)<*22 Cit!out %1A :ontribution B12<222 ER2RG B12<222 B1<222 "<222 "<'22 B)<'22

T!us< t!e B1<222 traditional %1A contribution would increase Nanice=s itemi@ed deductions b. B"22 EB)<*22 R B)<'22G; E6ample " &*; a; Mirb. and 4elinda are tr.ing to use t!e salaries to reduce t!e ta6able income o5 T!rus! to @ero EB0+)<222 R B)22<222 R B&)2<222 R B1")<222G; 3. so doing< t!e. can avoid t!e potential 5or double ta6ation; b; %5 t!e salaries paid to t!e c!ildren are deemed reasonable< T!rus!=s ta6able income is reduced to @ero; Eac! c!ild will report gross income o5 B'1<**+; T!e more liIel. result is t!at a substantial portion o5 t!e B1")<222 salar. pa.ments will be labeled as unreasonable compensation; %n t!is case< T!rus!=s ta6able income will be increased b. t!e amount o5 unreasonable compensation; Eac! o5 t!e c!ildren will report gross income e/ual to t!e amount labeled reasonable compensation; Mirb. and 4elinda will !ave additional dividend income e/ual to t!e amount o5 t!e unreasonable compensation; pp; *>* and *>+

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6-12

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua

&+;

T!e 5ollowing losses can be deducted b. Pegg.: Loss on sale o5 Sellow< %nc;< stocI T!e5t loss o5 uninsured business use car Loss on sale o5 :it. o5 (ewbur.port bonds #eductible loss B1<*22 1<)22 022 B'<222

(eit!er t!e B-<222 loss on t!e sale o5 Pegg.=s personal use car nor t!e B12<222 loss on t!e sale o5 !er personal residence is deductible because t!ese assets are personal use assets; p; *>+ &-; a; b; nder t!e cas! met!od< Aalcon can deduct onl. t!e salaries paid o5 B)22<222; T!e B')<222 o5 unpaid salaries can be deducted w!en paid ne6t .ear; nder t!e accrual met!od< t!e B)22<222 is deductible because bot! t!e all events test and t!e economic per5ormance test are satis5ied; T!ese tests also are satis5ied 5or t!e B')<222 o5 unpaid and accrued salaries; :onse/uentl.< Aalcon can deduct t!e B')<222 5or a total deduction o5 B)')<222 EB)22<222 Q B')<222G;

pp; *>- to *>12 &0; 4aud can deduct B1"2<222 in "21& 5or t!e rent 5or Aebruar. "21& t!roug! Nul. "21'; S!e does /uali5. under t!e one>.ear rule 5or prepaid e6penses since t!e period 5or w!ic! prepa.ments !ave been made does not e6tend past #ecember &1< "21'; E6ample $ross receipts Less: :oliseum rental Aood Ecost o5 goods soldG Souvenirs Ecost o5 goods soldG Per5ormers (et income 5or "21& B&22<222 B ")<222 &2<222 *2<222 122<222

'2;

E"1)<222G B -)<222

Since #ucI is an accrual basis ta6pa.er< it ma. accrue and deduct in "21& t!e costs o5 t!e per5ormers o5 B122<222 even t!oug! not paid until Nanuar. )< "21' Ei;e;< t!e economic per5ormance test is satis5iedG; 7owever< t!e cleaning cost o5 B12<222 ma. not be deducted until "21' w!en t!e services are per5ormed Ei;e;< at t!at time< t!e economic per5ormance test is satis5iedG; E6ample 0 '1; Onl. t!e B)22 paid to t!e attorne. to dra5t t!e lease and t!e B"<)22 paid to t!e attorne. to negotiate a reduction in t!e alimon. pa.ments to t!e 5ormer spouse are deductible b. #oug; T!ese e6penses are ordinar. and necessar. e6penses incurred in connection wit! rental propert. !eld 5or t!e production o5 income and 5or deductible alimon.; T!e ticIets and t!e related legal e6penses are not deductible because t!e. are personal in nature; Even i5 related to t!e conduct o5 a trade or business or t!e production o5 income< t!e. are disallowed as a deduction because t!e. violate public polic.; T!e B1<222 pa.ment 5or negotiating a reduction in c!ild support pa.ments is personal in nature; p; *>1"

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D$du!(i"n& and L"&&$&: In G$n$)a '"; a; T!e e55ect o5 t!e illegal gambling business on Trevor=s A$% is as 5ollows: $ross income #eductible e6penses: Salaries Pa.outs to winners %ncrease in A$% B)"<222 B -<222 "0<222 E&+<222G B1)<222

6>1*

T!e bribe to police o5 B+<)22 is not deductible since t!is e6pense violates public polic.; Trevor also must include t!e tip income o5 B1*<222 in !is gross income; b; c; Trevor=s ta6able income also increases b. B1)<222; Aor an illegal drug activit.< all o5 t!e e6penses are disallowed; T!ere5ore< it would appear t!at t!e illegal drug operation would increase Trevor=s A$% b. B)"<222; 7owever< t!e B*<"22 cost o5 goods sold is viewed as a reduction in calculating gross income rat!er t!an as an e6pense; T!ere5ore< t!e illegal drug operation increases Trevor=s A$% b. B')<-22 EB)"<222 R B*<"22G;

E6ample 1* '&; ''; Poll.=s deduction 5or t!e political contributions is B2; Political contributions cannot be deducted; p; *>1' a; nder t!e 5irst option< t!e salar. o5 Amber=s president would be B1<1+2<222 EB022<222 Q B"+2<222G; Since Amber is a publicl. !eld corporation< onl. B1<222<222 o5 t!is salar. is deductible< wit! t!e balance o5 B1+2<222 being disallowed as e6cessive e6ecutive compensation; T!e B"*<222 EB"2<222 Q B*<222G contribution to t!e de5ined contribution pension plan would be deductible; nder t!e second option< all o5 t!e compensation paid to t!e president is deductible assuming t!e statutor. re/uirements 5or a per5ormance>based compensation program are satis5ied; T!us< onl. t!e second option provides Amber wit! a deduction 5or all o5 t!e president=s proposed compensation; pp; *>1' and *>1) b; September 1*< "21& 7o55man and Smit!< :PAs )101 (atorp 3oulevard 4ason< O7 ')2'2

4s; Agnes 1iddle :!airperson o5 t!e 3oard o5 #irectors Amber< %nc; 122 Names Tower :leveland< O7 ''12* #ear 4s; 1iddle: % am responding to .our in/uir. regarding t!e proposed compensation plans 5or Amber=s president; nder one proposal< bot! t!e salar. and t!e pension contribution will be increased b. &2F; nder t!e ot!er option< a per5ormance>based compensation program will be implemented w!ic! is projected to provide about t!e same additional compensation and pension contribution 5or t!e president;
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6-14

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua T!e &2F increase option will produce a salar. o5 B1<1+2<222 and a pension contribution o5 B"*<222; O5 t!is amount< onl. B1<2"*<222 EB1<222<222 salar. and B"*<222 pension contributionG can be deducted b. Amber; T!e salar. paid to t!e president in e6cess o5 B1<222<222 is disallowed as e6cessive e6ecutive compensation; nder t!e per5ormance>based compensation option< all o5 t!e compensation Esalar.< bonus< and pension contributionG can be deducted assuming t!at t!e per5ormance> based compensation satis5ies t!e 5ollowing re/uirements: Suc! compensation is based on compan. per5ormance according to a 5ormula approved b. a board o5 directors compensation committee Ecomprised solel. o5 two or more outside directorsG and b. s!are!older vote; T!e per5ormance must be certi5ied b. t!is compensation committee; % recommend t!at .ou adopt t!e per5ormance>based compensation option; % believe t!at it will better ac!ieve Amber=s objective o5 placing a greater emp!asis on t!e relations!ip between per5ormance and compensation; %n addition< under t!is approac!< all o5 t!e compensation can be deducted on Amber=s Aorm 11"2; %5 .ou would liIe to !ave me worI wit! .ou in developing t!is program< let me Inow; Sincerel.< 1e6 Edward< :PA Partner pp; *>1' and *>1)

');

Since 8ermillion is a publicl. !eld corporation< it is subject to t!e e6cessive e6ecutive compensation deduction limit 5or t!e :EO and t!e 5our ot!er most !ig!l. compensated o55icers o5 B1 million eac!; Since t!e )F bonus does not satis5. t!e re/uirements t!at must be met to e6clude it 5rom covered compensation< t!e bonus is included wit! t!e salar. in appl.ing t!e limit; T!us< 8ermillion ma. deduct t!e 5ollowing: Salar. B1<222<222 1<222<222 1<222<222 1<222<222 1<222<222 1<"*2<222 1<122<222 -22<222 B-<1*2<222 1etirement Plan :ontribution B -2<222 +"<222 *'<222 *2<222 )*<222 '-<222 ''<222 &"<222 B')*<222

:EO E6ecutive vice president Treasurer 4arIeting vice president Operations vice president #istribution vice president 1esearc! vice president :ontroller

T!e limit does not appl. to t!e distribution vice president or t!e researc! vice president because t!e. are not included in t!e covered group Ei;e;< :EO plus top 'G; T!e retirement plan contribution is e6cluded 5rom t!e de5inition o5 covered compensation; pp; *>1' and *>1)

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D$du!(i"n& and L"&&$&: In G$n$)a '*;

6>1+

Even t!oug! (anc. decides not to pursue t!e e6pansion o5 !er !otel c!ain into anot!er cit.< t!e investigation e6penses o5 B&)<222 are deductible in t!e current .ear; 3ecause (anc. is in t!e !otel business< all investigation e6penses associated wit! t!e !otel business are deductible in t!e .ear paid or incurred; Since (anc. was not in t!e restaurant business< s!e can deduct onl. part o5 t!ese investigation e6penses; O5 t!e B)&<222< an amount o5 B"<222 DB)<222 R B&<222 Ereduction 5or e6cess over B)2<222GH can be immediatel. e6pensed; T!e balance o5 B)1<222 EB)&<222 R B"<222G is amorti@ed over a period o5 1-2 mont!s at t!e rate o5 B"-& per mont! EB)1<222 T 1-2G commencing in September Et!e mont! t!e business is startedG; :onse/uentl.< t!e total deduction 5or t!e .ear is B&)<222 5or t!e !otel investigation Q B&<1&" DB"<222 Q EB"-& K ' mont!sGH 5or t!e restaurant investment< or a total o5 B&-<1&"; pp; *>1)< *>1*< and :oncept Summar. *;1 a; b; c; d; 7e could deduct B)"<222; E6ample 17e could deduct B)"<222; E6ample 1(one o5 Terr.=s e6penses is deductible; E6ample 10 Terr. can immediatel. e6pense B&<222 and amorti@e t!e B'0<222 balance EB)"<222 R B&<222G over a period o5 1-2 mont!s beginning in October Et!e mont! t!e business is startedG; T!e deduction 5or "21& is B&<-1+ DB&<222 Q B-1+ EB'0<222 T 1-2 K & mont!sGH; E6ample "2

'+;

'-;

Ale6 must report t!e B1-<222 as revenues; All o5 t!e propert. ta6es o5 B&<222 can be deducted; 3ecause t!e remaining e6penses o5 B1*<")2 e6ceed t!e balance o5 B1)<222 EB1-<222 revenues R B&<222 propert. ta6esG< t!e B1)<222 is deductible as 5ollows: 4aterials and supplies tilities Advertising %nsurance #epreciation Esince depreciation is se/uenced last< onl. B"<+)2 o5 t!e B'<222 is eligibleG Total deductible e6penses B '<)22 "<222 )<222 +)2 "<+)2 B1)<222

T!ese e6penses o5 B1)<222 are classi5ied as miscellaneous itemi@ed deductions and will be subject to t!e "F>o5>A$% 5loor; :onse/uentl.< B1<"22 DEB'"<222 Q B1-<222G K "FH o5 t!ese e6penses are disallowed; Ot!er A$% 1evenues 5rom !obb. Less: E6penses Propert. ta6es 4iscellaneous itemi@ed deduction EB1)<222 R B1<"22G 1eportable net income 5rom !obb. Less: Personal e6emption Ta6able income pp; *>1+ and *>1B1-<222 E&<222G E1&<-22G 1<"22 E&<022G B&0<&22 B'"<222

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6-16 '0; a;

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua %5 t!e miniature !orse activit. is !eld to be a !obb.< Samant!a=s deductions associated wit! t!e !obb. ma. not e6ceed !er gross income 5rom t!e activit.; %ncome #educt: 3alance #educt: 4ortgage interest E12F K B"'<222G Propert. ta6es on !orse 5arm improvements Propert. ta6es on !ome E12F K B"<"22G Ot!er e6penses Entr. 5ees Aeed and veterinar. bills Supplies Publications and dues Travel Salar. and wages B"<'22 -22 ""2 B1<222 '<222 022 )22 "<&22 -<222 B &<222 +<222 1<222 B11<222 B""<222 E&<'"2G B1-<)-2

3alance #epreciation: On !orse e/uipment On !orse 5arm improvements On !ome E12F o55ice portionG Total Limited to: (et %ncome T!e items are !andled as 5ollows: A$% Plus: 7orse 5arm income (ew A$% %temi@ed deductions: %nterest and ta6es on !orse 5arm E!obb. portionG %nterest and ta6es on !ome EB"*<"22 R B"<*"2G Ot!er e6penses and depreciation o5 !obb. EB1*<+22 Q B1<--2G Less: "F o5 A$% EB1""<222G

E1*<+22G B 1<--2

E1<--2G B R2R

B122<222 ""<222 B1""<222 B &<'"2 "&<)-2 B1-<)-2 E"<''2G

B"+<222 B1*<1'2

(ote t!at t!e deductions o5 t!e miniature !orse operation are B10<)*2 EB&<'"2 Q B1*<1'2G o5 w!ic! B&<'"2 were deductible an.wa.; T!e net increase in ta6able income is: %ncome Ot!erwise nondeductible e6penses (et increase in ta6able income b; B""<222 E1*<1'2G B )<-*2

%5 t!e miniature !orse activit. is classi5ied as a business< Samant!a would be able to deduct B0<1"2 for A$% as 5ollows: 1emainder o5 income a5ter ot!er e6penses and be5ore amounts t!at a55ect basis EdepreciationG Esee part a; aboveG Less: depreciation #eduction for A$% B 1<--2 E11<222G EB 0<1"2G

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D$du!(i"n& and L"&&$&: In G$n$)a

6>1/

%n addition< Samant!a could deduct t!e remaining propert. ta6es and mortgage interest o5 B"&<)-2 as an itemi@ed deduction; T!e net e55ect is as 5ollows: Loss on !orse 5arm Add: ot!erwise deductible ta6es and interest (et decrease is ta6able income EB0<1"2G &<'"2 EB)<+22G

:ontrast t!is decrease o5 B)<+22 wit! t!e increase o5 B)<-*2 in part a; T!e B11<)*2 di55erence is due to t!e di55erence between !obb. and business treatment; E6amples "" and "& )2; Since t!e !ouse was rented 5or less t!an 1) da.s< t!e rental income o5 B)<222 is e6cluded 5rom Adelene=s gross income; T!e onl. e6penses t!at can be deducted in t!is case are t!e real propert. ta6es o5 B&<-22 and t!e mortgage interest o5 B+<)22; T!ese e6penses are classi5ied as itemi@ed deductions Ei;e;< deductions from A$%G; T!ere5ore< t!ere is no e55ect on A$%; p; *>"2 a; $ross income #educt: Ta6es and interest E&2/&*) K B11<)22G 1emainder to appl. to rental operating e6penses and depreciation tilities and repairs D&2/)2 K EB"<'22 Q B1<222GH 1emainder #epreciation E&2/)2 K B+<)22 L B'<)22< limited to remainderG (et rental income B+<222 E0')G B*<2)) E"<2'2G B'<21) E'<21)G B R2R

)1;

S!e can itemi@e B12<))) o5 propert. ta6es and mortgage interest EB11<)22 total less B0') allocated to rentalG; T!us< under t!e court=s approac!< Anna !as no net rental income and !as an itemi@ed deduction o5 B12<))); E6ample "0 T!e roo5 replacement o5 B1"<222 is a capital e6penditure and t!e related depreciation is included in t!e B+<)22 o5 depreciation; b; $ross income #educt: Ta6es and interest E&2/)2 K B11<)22G 1emainder to appl. to rental operating e6penses and depreciation tilities and repairs D&2/)2 K EB"<'22 Q B1<222G L B"<2'2< limited to remainderH (et rental income B+<222 E*<022G B 122 E122G B R2R

Anna can deduct t!e remaining ta6es and interest o5 B'<*22 EB11<)22 less rental allocation o5 B*<022G as itemi@ed deductions; nder t!e %1S=s approac!< s!e !as no net rental income and !as an itemi@ed deduction o5 B'<*22; E6ample "-

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6-10 )";

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua Since Anna used it 5or less t!an 1) da.s< it is classi5ied as rental propert.; Percentage o5 use $ross income E6penses: %nterest and ta6es EB0<222 Q B"<)22G tilities and repairs EB"<'22 Q B1<222G #epreciation EB+<222G Total e6penses (et income ElossG 1ental -+F B +<222 B12<22) "<0)*<202 B10<2)& EB1"<2)&G Personal 1&F B R2R B1<'0) ''" 012 B"<-'+ B R2R

Anna could deduct B&") EB"<)22 K 1&FG o5 propert. ta6es as itemi@ed deductions and taIe a rental loss deduction for A$% o5 B1"<2)&; T!e mortgage interest o5 B1<1+2 EB0<222 K 1&FG is not deductible as an itemi@ed deduction because it is not /uali5ied residence interest; E6ample ") T!e roo5 replacement o5 B1"<222 is a capital e6penditure and t!e related depreciation is included in t!e depreciation o5 B+<)22; pp; *>"* and *>"+ %ncome: Salar. B'&<222 #ividend '22 1ental o5 vacation !ome E(ote "G R2R Adjusted gross income B'&<'22 %temi@ed deductions: State income ta6es Egreater t!an sales ta6G Propert. ta6 on !ome %nterest on !ome mortgage %nterest and propert. ta6es on vacation !ome E(ote "G :!aritable contributions Ta6 return preparation 5ee E(ote &G Ta6able income be5ore personal e6emption (otes E1G T!e municipal bond interest o5 B"<222 is e6cludible 5rom gross income and t!e interest e6pense o5 B&<122 on t!e loan to bu. municipal bonds is not deductible; p; *>"0 1ental income Less: Ta6es and interest E*2/&*) K B)<-)*G 1emainder Less: tilities and maintenance E1/" K B"<*22G 1emainder Less: #epreciation EB&<)22< limited to B1<+&+G (et income 5rom vacation !ome B'<222 E0*&G B&<2&+ E1<&22G B1<+&+ E1<+&+G B R2R B&<&22 "<"22 -<'22 '<-0& 1<122 R2R

)&;

E10<-0&G B"&<)2+

E"G

(ote t!at B'<-0& EB)<-)* total B0*& vacation !ome portionG o5 propert. ta6es and mortgage interest on t!e vacation !ome are itemi@ed deductions; E6ample "0 E&G Ta6 preparation 5ees are reduced b. "F o5 A$% Ein t!is case "F o5 A$% e6ceeds B&22G;

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D$du!(i"n& and L"&&$&: In G$n$)a )'; a; Sales revenue #educt: B))<222

6>11

A$%

:ost o5 goods sold Advertising tilities 1ent %nsurance Cages to 3o.d

B"1<222 1<222 "<222 '<)22 1<)22 -<222

E&-<222G B1+<222

Elisa and :l.de can deduct onl. t!e B-<222 in wages t!e. paid to 3o.d; b; c; :!elsie is not entitled to a deduction on !er ta6 return; T!e obligation is t!at o5 Elisa and :l.de since it related to t!eir business; %5 :!elsie !ad made a gi5t o5 t!e B1<222 to Elisa and :l.de or !ad s!e loaned t!e B1<222 to t!em< t!en t!e. could deduct it assuming t!e. pa. t!e B1<222 to 3o.d;

E6ample &" )); a; Na. is selling t!e assets o5 t!e sole proprietors!ip; O5 t!e sales price o5 B"22<222< B1+&<222 is allocated to t!e listed assets in accordance wit! t!eir 5air marIet values; T!e recogni@ed gain on eac! asset is t!e di55erence between its 5air marIet value and its basis; T!e residual B"+<222 EB"22<222 R B1+&<222G appears to represent a pa.ment 5or goodwill; T!ere5ore< since Na. !as a basis o5 B2 5or t!e goodwill< !e !as a gain o5 B"+<222; Since goodwill is a capital asset< t!e gain is classi5ied as a long>term capital gain; Long>term capital gains are eligible 5or bene5icial ta6 rates; Lois is purc!asing t!e assets o5 t!e sole proprietors!ip; 7er basis 5or eac! asset is t!e amount paid 5or it Ei;e;< t!e 5air marIet valueG; %t appears t!at t!e e6cess B"+<222 EB"22<222 R B1+&<222G represents a pa.ment 5or goodwill; T!e goodwill is amorti@ed over a statutor. 1)>.ear period; Anot!er option 5or Lois would be to get Na. to agree t!at part or all o5 t!e B"+<222 is a pa.ment 5or a covenant not to compete; Even t!oug! Na. is age +2 and indicates !e is going to retire< t!is would give Lois additional securit.; LiIe goodwill< t!e covenant is amorti@able over a statutor. 1)>.ear period regardless o5 t!e li5e o5 t!e covenant; c; C!et!er an allocation is made to a covenant does not a55ect t!e ta6 conse/uence to Lois Ebot! are amorti@able over a 1)>.ear periodG; $oodwill is a capital asset to Na.< w!ereas t!e sale o5 a covenant not to compete would produce ordinar. income; Since Na. is in t!e &)F marginal ta6 bracIet< t!ere is a bene5it to !im o5 using t!e alternative ta6 on capital gains in calculating !is ta6 liabilit.; T!ere5ore< assuming Lois is secure t!at Na. is going to retire Ei;e;< s!e does not need t!e legal protection o5 a covenantG< s!e ma. negotiate to !ave part o5 Na.=s ta6 bene5it o5 t!e goodwill assigned to !er t!roug! an adjustment o5 t!e B"22<222 purc!ase price;

b;

p; *>"+ )*; a; b; 3rittan.=s B"'<222 loss EB1*2<222 amount reali@ed R B1-'<222 adjusted basisG is not deductible due to J "*+; %5 sold 5or B102<222< 1idge=s recogni@ed gain is B*<222 DB102<222 Esales priceG less B1*2<222 EbasisG< reduced b. t!e B"'<222 loss t!at previousl. was not allowed to 3rittan.H;

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6-20

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua %5 sold 5or B1)"<222< a B-<222 loss DB1)"<222 Esales priceG less B1*2<222 EbasisGH is recogni@ed b. 1idge; T!e B"'<222 loss t!at was reali@ed b. 3rittan. is not deductible b. eit!er 3rittan. or 1idge and is lost permanentl.; %5 sold 5or B1+'<222< t!ere is no recogni@ed gain to 1idge DB1+'<222 Esales priceG less B1*2<222 EbasisG< reduced b. B1'<222 o5 t!e B"'<222 loss t!at previousl. was not recogni@ed b. 3rittan.H; T!e remaining B12<222 o5 unrecogni@ed loss is lost permanentl. as a deduction 5or bot! 3rittan. and 1idge; c; Nune "1< "21& 4s; 3rittan. :alli!an &" :ountr. Lane Lawrence< MS **2') #ear 4s; :alli!an: As .ou re/uested in .our note< % am providing .ou wit! t!e ta6 conse/uences o5 t!e proposed sale o5 stocI to .our son 1idge; Alt!oug! .ou would !ave a potential loss o5 B"'<222 EB1*2<222 selling price R B1-'<222 costG< .ou would not be able to recogni@e t!is loss on .our ta6 return; T!e ta6 law disallows t!e recognition o5 losses between certain related parties; %5 .ou do sell t!e stocI to 1idge< !is ta6 basis 5or calculating gain or loss on a subse/uent sale b. !im would be !is cost o5 B1*2<222; 7owever< i5 !e s!ould sell it at a gain< !e could use as muc! o5 .our B"'<222 disallowed loss as necessar. to reduce !is gain to @ero; Arom a planning perspective< .ou could recogni@e t!e B"'<222 loss on .our ta6 return i5 .ou were to sell t!e stocI to an unrelated part. rat!er t!an selling it to 1idge; %5 .ou would liIe to discuss t!is 5urt!er< please let me Inow; Sincerel.< Ellen Allen< :PA Ta6 Partner E6amples &) to &+ 7o55man and Smit!< :PAs )101 (atorp 3oulevard 4ason< O7 ')2'2

)+;

1obin :orporation can taIe a deduction 5or interest o5 B"<-22 in "21& on t!e loan 5rom Peter< but must de5er t!e deduction o5 B"<-22 on t!e loan 5rom %sabelle until "21' w!en it is paid; 3ot! %sabelle and Peter !ave interest income in "21' w!en it is received; T!e reason 5or t!e di55erent treatment is t!at Peter owns !is 10F plus Eb. attributionG %sabelle=s "*F 5or a total o5 ')F; Since t!is is not greater t!an )2F< !e is not a related part. wit! respect to 1obin; %sabelle< !owever< owns !er s!ares E"*FG< plus Eb. attributionG !er !usband=s s!ares E10FG< !er 5at!er=s s!ares E")FG< and !er mot!er=s s!ares E1)FG 5or a total o5 -)F owners!ip; Section "*+ disallows t!e deduction 5or t!e accrued e6pense in "21& because %sabelle and 1obin are related parties; pp; *>"+ and *>"-

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D$du!(i"n& and L"&&$&: In G$n$)a

6>21

)-;

a;

Amount reali@ed Adjusted basis 1eali@ed loss 1ecogni@ed loss

B1"<222 E1+<222G EB )<222G B R2R

3onnie and P!illip are related parties under J "*+; T!ere5ore< 3onnie=s reali@ed loss o5 B)<222 is disallowed; P!illip=s adjusted basis 5or t!e stocI is !is cost o5 B1"<222; b; Amount reali@ed Adjusted basis 1eali@ed loss 1ecogni@ed loss B+2<222 E-)<222G EB1)<222G EB1)<222G

Amos and 3o.d are not related parties under J "*+; T!ere5ore< Amos=s reali@ed loss o5 B1)<222 is recogni@ed; 3o.d=s adjusted basis 5or t!e land is !is cost o5 B+2<222; c; Amount reali@ed Adjusted basis 1eali@ed loss 1ecogni@ed loss B10<222 E"2<222G EB 1<222G B R2R

Susan and !er w!oll. owned corporation are related parties under J "*+ Ei;e;< s!e owns greater t!an )2F in value o5 t!e outstanding stocIG; T!ere5ore< Susan=s reali@ed loss o5 B1<222 is disallowed; T!e corporation=s adjusted basis 5or t!e bond is its cost o5 B10<222; d; Amount reali@ed Adjusted basis 1eali@ed loss 1ecogni@ed loss B1-<)22 E"2<222G EB 1<)22G EB 1<)22G

1on and Agnes are not related parties under J "*+; T!ere5ore< 1on=s reali@ed loss o5 B1<)22 is recogni@ed; Agnes=s adjusted basis 5or t!e trucI is !er cost o5 B1-<)22; e; Amount reali@ed Adjusted basis 1eali@ed gain 1ecogni@ed gain B""2<222 E1+)<222G B ')<222 B ')<222

4art!a and Mim are related parties under J "*+; 7owever< J "*+ applies onl. to loss transactions; 4art!a=s reali@ed gain o5 B')<222 is recogni@ed< and Mim=s adjusted basis 5or !er partners!ip interest is !er cost o5 B""2<222; pp; *>"+ and *>")0; 4urp!. can deduct onl. t!e interest e6pense attributable to ta6able income; T!e interest attributable to t!e municipal interest income is not deductible; T!us< onl. B1+<)22 EB&)2<222/B'22<222 K B"2<222G is deductible; E6ample &0

9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;

6-22 *2; a;

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua 1obert can onl. deduct amounts w!ic! are !is obligations; 7e ma. not deduct amounts t!at are obligations o5 !is daug!ter< Anne; T!ere5ore< 1obert can deduct onl. t!e 5ollowing as itemi@ed deductions: Propert. ta6es on !is !ome 4ortgage interest on !is !ome Total B &<222 -<222 B11<222

T!e repairs o5 B1<"22 and t!e utilities o5 B"<+22 paid b. 1obert associated wit! !is !ome are nondeductible personal e6penditures; T!e roo5 replacement costs o5 B'<222 on 1obert=s !ome are not deductible< but !e can add t!em to !is adjusted basis 5or t!e !ome; b; Anne cannot deduct an. o5 t!e e6penses t!at would ot!erwise be deductible b. !er Ei;e;< propert. ta6es o5 B1<)22 and mortgage interest o5 B'<)22G because s!e did not pa. t!em; 1obert=s deductions are deductions from A$% Eitemi@ed deductionsG; Anne could deduct t!e propert. ta6es o5 B1<)22 and t!e mortgage interest o5 B'<)22 as itemi@ed deductions i5 s!e paid t!em; T!ere5ore< 1obert s!ould maIe a gi5t o5 B*<222 to Anne so t!at s!e could pa. t!ese e6penses;

c; d;

pp; *>&< *>'< *>"'< *>")< and *>&" CUMULATI2E PROBLEMS *1; Salar. %n!eritance E(ote 1G $i5t E(ote 1G Li5e insurance proceeds E(ote 1G (et gain on stocI sale E(ote "G %nterest income E(ote &G #ividend income Pri@e Alimon. Partners!ip income E(ote 'G A$% %temi@ed deductions: :!aritable contributions EB&<)22 Q B1<)22G 7ome mortgage interest Propert. ta6es EB&<122 Q B1<122G State income ta6es EB&<122 Q B1<222G E(ote )G 4edical e6penses E(ote *G Less: Personal and dependenc. e6emptions E(ote 0G Ta6able income Ta6 on B*0<-)2 E(ote 12G Less: Cit!!olding and estimated ta6 EB-<)22 Q B&<-22G (et ta6 pa.able Eor re5und dueG 5or "21" B +)<222 R2R R2R R2R "<)22 "<222 1<-22 +)2 1)<222 )<&22 B12"<&)2 B)<222 +<-22 '<"22 '<122 R2R

E"1<122G B -1<")2 E11<'22G B *0<-)2 B 11<*-' E1"<&22G EB *1*G

See t!e ta6 return solution beginning on page *>"* o5 t!e Solutions 4anual;

9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;

D$du!(i"n& and L"&&$&: In G$n$)a (otes E1G E"G

6>2*

T!e in!eritance o5 B*")<222< li5e insurance proceeds o5 B&22<222< and t!e gi5t o5 B1&<222 all are e6cludible 5rom 1oberta=s gross income; 1oberta=s adjusted basis 5or t!e Amber stocI is B"'<222< t!e purc!ase price; A cousin is not a related part.; Even i5 a cousin were a related part.< 1oberta=s adjusted basis would still be t!e purc!ase price o5 B"'<222; T!ere5ore< 1oberta !as a recogni@ed loss o5 B'<222 EB"2<222 amount reali@ed R B"'<222 adjusted basisG; Since !er !olding period 5or t!e stocI is long term< t!e loss is classi5ied as long>term capital loss; 1oberta !as a gain on t!e sale o5 t!e Aalcon stocI o5 B*<)22 EB1&<)22 amount reali@ed R B+<222 adjusted basisG; Since !er !olding period 5or t!e stocI is long>term< t!e gain is classi5ied as long>term capital gain; T!us< s!e !as capital gain net income and net capital gain o5 B"<)22 EB*<)22 R B'<222G; T!e B"<222 o5 interest received 5rom Airst Savings 3anI is includible in 1oberta=s gross income; T!e B&<+)2 o5 interest received on t!e :it. o5 Spring5ield Sc!ool bonds is e6cludible 5rom gross income; 1oberta reports !er distributive s!are o5 t!e partners!ip ta6able income o5 B)<&22 rat!er t!an t!e amount o5 t!e distribution s!e received o5 B'<-22; T!e state income ta6es o5 B'<122 e6ceed t!e sales ta6 table amount o5 B00'; 1oberta=s deductible medical e6penses are B2; 1oberta Nason E(ote 0G Less reimbursement Less +;)F o5 B12"<&)2 #eductible medical e6penses B)<222 -22 B)<-22 E1<)22G B'<&22 E+<*+*G B R2R

E&G E'G E)G E*G

E+G E-G E0G

T!e parIing ticIet o5 B1<222 and t!e related attorne.=s 5ee o5 B)22 cannot be deducted; T!e political contribution o5 B")2 cannot be deducted; 1oberta can taIe a dependenc. e6emption 5or Nason since s!e is t!e custodial parent and did not waive Ei;e;< no Aorm -&&"G t!e e6emption in "21"; Ca.ne providing more o5 Nason=s support t!an 1oberta does is irrelevant; 1oberta also can taIe a dependenc. e6emption 5or Nune; T!ere5ore< 1oberta=s deduction 5or personal and dependenc. e6emptions is B11<'22 EB&<-22 K &G; T!e ta6 liabilit. is B11<*-'; T!e dividend income and net capital gain are ta6ed at a 1)F rate; B'<&22 K 1)F L B*') T!e ta6 liabilit. as a !ead o5 !ouse!old on t!e balance o5 B*)<))2 EB*0<-)2 R B'<&22G 5rom t!e Ta6 Table is B11<2&0; So t!e ta6 liabilit. is B11<*-' EB*') Q B11<2&0G;

E12G

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6-24 *"; Ta6 :ompliance

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua

Salaries EB0)<222 Q B)"<222G E(ote 1G %nterest on certi5icates o5 deposit S!are o5 S corporation income E(ote "G Award :!ild support E(ote &G A$% E(ote 'G %temi@ed deductions: 4edical e6penses E(ote )G :!aritable contributions State income ta6es EB'<+22 Q B&<122 Q B1<*22GE(ote *G 7ome mortgage interest Propert. ta6es Personal and dependenc. e6emptions E" K B&<-22G E(otes + and -G Ta6able income Ta6 on B1"2<-22 E(ote 12G Less: Cit!!olding EB"2<"22 Q B&<222G (et ta6 pa.able Eor re5und dueG 5or "21" (otes E1G

B1'+<222 &<&22 1<)22 &<222 R2R B1)'<-22 B R2R &<+22 0<'22 -<"22 '<022

E"*<"22G B1"-<*22 E+<*22G B1"2<+22 B ""<2)E"&<"22G EB 1<1'"G

T!e medical insurance premiums o5 B1"<0*2 EB-<222 Q B'<0*2G paid b. t!eir emplo.ers are e6cludible 5rom gross income; LiIewise< t!e B+<&22 o5 medical bene5its received under t!e plan b. 4ar. Nane are e6cludible; 4ar. Nane includes !er s!are o5 t!e S corporation income o5 B1<)22 in !er gross income even t!oug! s!e received cas! distributions o5 onl. B1<122; :!ild support pa.ments o5 B1)<222 are not deductible; See :!apter '; T!e investigation e6penses o5 B1)<222 incurred b. No!n and associated wit! t!e retail computer 5ranc!ise are not deductible; T!is result occurs because No!n was not in a business t!at was t!e same as or similar to t!e one being investigated< and t!e new business was not ac/uired; No!n pa.s medical insurance premiums o5 B"<222 and 4ar. Nane pa.s B1<"'2; 4ar. Nane pa.s noncovered medical e6penses o5 B1<&22; T!eir medical e6pense deduction is B2 since t!eir pa.ments are less t!an 12F o5 A$% E12F K B1)'<-22 L B1)<'-2G; T!e state income ta6es paid o5 B0<'22 EB'<+22 Q B&<122 Q B1<*22G e6ceed t!e state sales ta6es o5 B"<222; 4ar. Nane=s 5at!er does not /uali5. as a dependent; No!n and 4ar. Nane do provide over !al5 o5 !is support Ei;e;< B0<)22 5urnis!ed b. t!em compared to B)<'22 provided b. !er 5at!erG; 7owever< t!e 5at!er=s gross income o5 B*<&22 EB"<-22 salar. Q B&<)22 unemplo.ment compensation bene5itsG e6ceeds t!e allowable amount o5 less t!an B&<022; Since t!e gross income test is not satis5ied< No!n and 4ar. Nane ma. not taIe t!e dependenc. deduction 5or !er 5at!er; (ote t!at t!e Social Securit. bene5its o5 B'<122 were not included in t!e 5at!er=s gross income;

E"G E&G E'G

E)G

E*G E+G

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D$du!(i"n& and L"&&$&: In G$n$)a E-G

6>2+

Nune is t!e custodial parent; Since t!ere is no indication t!at Nune !as waived !er rig!t to t!e dependenc. deduction 5or 1od< s!e /uali5ies 5or t!e dependenc. deduction rat!er t!an No!n; T!e B1)2 ticIet associated wit! 4ar. Nane running a red lig!t is a nondeductible personal e6penditure; Since t!e. are 5iling jointl.< t!eir ta6 liabilit. 5or "21& is calculated as 5ollows: On B+"<)22 '-<&22 K ")F B 0<0-& 1"<2+) B""<2)-

E0G E12G

Tax Planning :L%E(T LETTE1 7o55man and Smit!< :PAs )101 (atorp 3oulevard 4ason< O7 ')2'2

#ecember 1*< "21& 4r; and 4s; No!n #ia@ "2' S!oe Lane 3lacIsburg< 8A "'2*1 #ear 4r; and 4s; #ia@:

% am responding to .our in/uir. regarding w!et!er 4r; #ia@ s!ould receive a B&2<222 bonus in "21& or dela. receiving it until "21'; 3ased on t!e data provided b. .ou< % !ave calculated .our ta6 liabilit. 5or bot! .ears assuming t!e bonus is received in "21& and assuming t!e bonus is received in "21';? T!e ta6 liabilit. results are as 5ollows: 3onus received in "21& "21& ta6 liabilit. "21' ta6 liabilit. Total 3onus received in "21' "21& ta6 liabilit. "21' ta6 liabilit. Total B"0<*02 -<-)B&-<)'B""<2)1)<*2B&+<***

%5 .ou dela. t!e receipt o5 t!e bonus until "21'< .ou will save B--" EB&-<)'- R B&+<***G; T!is ignores an. earnings Enet o5 ta6esG .ou could receive on t!e B&2<222 i5 .ou receive t!e bonus in "21&; 7owever< since t!e decision is to receive t!e bonus in #ecember "21& or Nanuar. "21'< t!e amount o5 suc! earnings is liIel. to be negligible; %5 % can be o5 5urt!er assistance< let me Inow; Sincerel.< 1ene 1oss< :PA Partner ?"21& ta6 rates used;
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6-26

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua TAU A%LE 4E4O1A(# 4 #ecember 0< "21& A1O4: $ene 1oss S 3NE:T: No!n and 4ar. Nane #ia@ Ta6 Planning 1egarding Timing o5 3onus No!n #ia@< a regular ta6 client< !as an opportunit. to receive a B&2<222 bonus in #ecember "21& or in Nanuar. "21'; 7e !as asIed t!at we recommend to !im w!et!er !e s!ould receive t!e bonus in "21& or dela. it until "21'; E6pected di55erences in t!e data provided 5or t!e "21' return and t!at 5or t!e "21& return are as 5ollows: E1G T!e. are e6pecting a c!ild in Nanuar. "21'; E"G 4ar. Nane will /uit worI on #ecember &1< "21& to sta. !ome wit! t!e c!ild; T!ere5ore< !er salar. will decrease b. B)"<222 and t!e state income ta6es wit!!eld on t!e B)"<222 will decrease b. B&<122; E&G 4ar. Nane does not e6pect to receive t!e B&<222 award; E'G 4edical bene5its received b. 4ar. Nane in "21' will be B0<222 rat!er t!an t!e B+<&22 received in "21&; 3ased on t!e data provided 5or t!e "21&? ta6es and t!e above assumptions< % made t!e 5ollowing calculations: Ta6 wit! t!e 3onus: "21& "21' Ta6able income in "21& B1"2<-22 B1"2<-22 3onus &2<222 &2<222 Less: 4ar. Nane=s salar. E)"<222G Award E&<222G Additional e6emption 5or c!ild E&<022G EB&<022 K 1G Plus: #ecrease in itemi@ed deductions &<122 Ta6able income wit! bonus B1)2<-22 B0)<222 Ta6 B "0<*02 B1)<*2Ta6 wit!out t!e 3onus: Ta6able income wit! bonus B1)2<-22 B0)<222 Less: 3onus E&2<222G E&2<222G Ta6able income wit!out bonus B1"2<-22 B*)<222 Ta6 B ""<2)B -<-)Ta6 taIing t!e bonus in "21& Aor "21& B"0<*02 Aor "21' -<-)Total ta6 B&-<)'Ta6 taIing t!e bonus in "21' Aor "21& B""<2)Aor "21' 1)<*2Total ta6 B&+<*** T!e. will save B--" EB&-<)'- R B&+<***G b. de5erring t!e bonus to Nanuar. "21'; ?"21& ta6 rates used;

Proposed solutions to t!e R$&$a)!3 P)"4 $#& are 5ound in t!e %nstructor=s $uide; Previousl.< t!ese items were a part o5 t!e %nstructor=s :ompanion Site 5or t!e te6tbooI;
9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;

D$du!(i"n& and L"&&$&: In G$n$)a *1;

6>2/

9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;

6-20 *1; continued

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua

9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;

D$du!(i"n& and L"&&$&: In G$n$)a *1; continued

6>21

9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;

6-*0 *1; continued

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua

9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;

D$du!(i"n& and L"&&$&: In G$n$)a *1; continued

6>*1

9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;

6-*2 *1; continued

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua

9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;

D$du!(i"n& and L"&&$&: In G$n$)a *1; continued

6>**

9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;

6-*4 *1; continued

2014 Individua In!"#$ Ta%$&'S" u(i"n& Manua

9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;

D$du!(i"n& and L"&&$&: In G$n$)a NOTES

6>*+

9 "21' :engage Learning; All 1ig!ts 1eserved; 4a. not be scanned< copied or duplicated< or posted to a publicl. accessible website< in w!ole or in part;