Accounting 5135

Fall 2013
Naples
ANSWER SHEET
TEST #2
MULTIPLE CHOICE (30 Points; 3 points each)
1.

b.

2.

e.

3.
4.

d.
c.

5.

c.

expenses
6.
a.
7.

c.

deduction.
8.
e.
9.

b.

under
10.
c.

The period must be substantially longer than a normal workday and require rest or
sleep, but need not be either overnight or be more than 24 hours.
Since reimbursed in full under an adequate accounting, the reimbursement is a
"wash" and need not be reported at all on the return.
Punitive damages are always taxable per Section 104.
Ed and Marta's studies qualify them for a new trade/business and therefore would
not be deductible.
All the expenses are valid business expenses, but the meals and entertainment must
be reduced by the 50% disallowance. Since she is self-employed, all the
can be taken above-the-line (not subject to the 2% floor).
Life insurance proceeds are excludible from gross income under Section 101. There
was no transfer for valuable consideration that would change this result.
Federal income taxes and license fees are nondeductible under Sec. 164. The state
sales tax is also nondeductible since will take the larger state income tax
State, local and foreign real property taxes are deductible.
Home mortgage ($3,600) plus investment interest (limited to $100 of net investment
income) = $3,700 that is deductible. Personal interest and interest to carry taxexempt obligations are nondeductible.
Capitalization is not provided for with medical expenses, and the increase in value
of the residence must be subtracted. The tax advice may only be deducted
Sec. 212 as a miscellaneous itemized deduction (subject to the 2% floor).
The deduction is based on the 40-mile distance between the two jobs.

PROBLEMS (35 Points; 7 points each)

1.

The taxpayers 2014 taxable income was reduced by $5,500 as a result of paying the state income
tax. Therefore, under the tax benefit rule, the $900 refund must be included in 2015 gross income. 2.

To be currently deductible as a business expense, the expenditure must be (i) incurred in a

trade or business; (ii) ordinary and necessary; (iii) reasonable, and (iv) not capital in nature. Issues
arise in this problem with at least the last two requirements. Whether $50,000 or $35,000 is the
amount of trade or business expenditure turns on whether accepting the higher bid from her brotherin-law was "reasonable." Clearly a businessperson does not to take the lowest bid if a reasonable
person would have paid a higher amount. So while the IRS would certainly scrutinize her reasons
for selecting her brother-in-law, if they believe her explanations (which appear reasonable) they
should allow the $50,000 expenditure. But whether or not she can take the deduction this year will
also depend on if she must capitalize the expenditure. Teresa will argue that the work was a "repair"
rather than a capital expense. This will be a question of fact -- whether the patching represented an
improvement or not.
3.
Josh's trip to Florida is not for general improvement of health or for treatment he clearly
could have received locally. So his transportation to Florida ($300) would likely be permissible as a
medical expense as in the Bilder case. Section 213(d)(2)(enacted in response to Bilder) would limit
Josh to no greater than $50/night for lodging. But since a significant part of the trip was for
pleasure (trip to Disneyworld) none of the lodging would be deductible under the statute! No
allowance for meals outside the medical facility is allowed. So Josh would be limited to $300
medical expense (further reduced by the 10% of AGI floor).
4.
Henry can take $4,000 of the expense above line as Higher Education Expense under
Section 222 since he is not disqualified due to his modest income. Any further deduction would
have to be under Section 162. Education will be deductible under Section 162 if it maintains or
improves skills in taxpayers trade or business. Notwithstanding this, it will be nondeductible if the
education is essential to satisfy the minimum requirements for a trade/business or will qualify the
taxpayer for a new trade/business. Harry is in the trade/business of tax accounting when he goes to
get his M.B.T. Clearly the further education improves his skills in that trade/business (this is an
objective test; it is irrelevant what Harry intends to do with the education). Further, the degree
neither meets the minimum education requirements for tax accounting (Henry already has that) or
qualifies him for a new trade/business. So his excess tuition and other educational expenses
($5,000) are deductible below-the-line subject the 2% floor ($5000 - $800 = $4200). The other
expenses are not deductible unless Henry is "away from home." This would not be the case here
since he had a present intent to stay in Florida indefinitely.
5.
First, the transaction will be treated as a "bargain sale" (part sale/part charitable
contribution). The sale part will be allocated a basis of $45,000 ($60,000/$80,000 x $60,000),
resulting in a gain of $15,000. The charitable deduction will be $20,000. However, since this is
capital gain property contributed to a public charity, she can take a deduction equal to only 30% of
her contribution base in the current year ($6,000). The other $14,000 must be carried forward.