South Western Federal Taxation 2016 Comprehensive 39th Edition Hoffman Solutions Manual

South-Western Federal Taxation 2016
Comprehensive 39th Edition Hoffman

Solutions Manual
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CHAPTER 12
TAX CREDITS AND PAYMENTS
SOLUTIONS TO PROBLEM MATERIALS
NOTE TO INSTRUCTOR: Several of the credits discussed in Chapter 12 expired on December 31, 2014.
However, because Congress is expected to extend these credits, the Discussion Questions and Problems
assume this is the case.
DISCUSSION QUESTIONS
1. (LO 1) A taxpayer whose marginal tax rate is less than 25% would be better off taking a credit of
25%. However, if the marginal rate is greater than 25%, a taxpayer would benefit more from taking a
deduction. Alternatively, if the item were deductible from AGI (i.e., as an itemized deduction), a
benefit would result only if the taxpayer itemized his or her deductions.
2. (LO 3) Among the relevant tax issues for Clint are the following.
• Availability of tax credit for rehabilitation expenditures.
• Ability to use a nonrefundable credit.
• Potential recapture of rehabilitation credit if property is disposed of prematurely.
• Self-employment tax calculation.
• Need for estimated tax payments.
• Calculation of depreciation expense once building is placed in service.
• Allocation of expenses between rental and personal use portions of the renovated building.
• Availability of office-in-home deduction.
• Impact of passive activity loss rules on deductibility of rental losses (if any) once building is
renovated.
3. (LO 3) For nonresidential buildings and residential rental property that are not certified historic
structures, a 10% credit is available for rehabilitation expenditures if the building was originally
placed in service before 1936. For residential and nonresidential certified historic structures, the credit
rate is 20%. The rehabilitation expenditures must exceed the greater of $5,000 or the adjusted basis of
the property before the rehabilitation.
4. (LO 4) Yes, the earned income credit is a form of a negative income tax because it is a refundable
credit even for taxpayers who do not have any income tax liability.
5. (LO 4) The earned income credit has been part of the U.S. income tax for years. It is meant to provide
tax equity to low-income taxpayers and to encourage them to enter and remain in the workforce. The
credit is designed ro reimburse the taxpayer for many Federal taxes, including the income, Social
Security, and gasoline taxes.
12-1
© 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
12-2 2016 Comprehensive Volume/Solutions Manual
6. (LO 4, 7) If Polly and Leo’s AGI is $75,000, they will save income taxes by taking advantage of the
plan because income taxes will be avoided on the $5,000 in salary “given up,” and the reimbursement
of child care expenses is excluded from gross income. Alternatively, if Polly does not take advantage
of the plan, her income taxes will be $90 higher than they otherwise would be.
Salary $5,000
Income tax rate × 25%
Income tax on salary $1,250
Less: Credit for child and dependent care expenses ($5,800 × 20%) (1,160)
Net income tax $ 90
In addition, to the extent Polly participates in the plan, her FICA taxes will be reduced by $382.50
($5,000 × 7.65%), given that her salary does not exceed $118,500 in 2015. So, in total, Polly and Leo
will save $473 ($90 + $383) in taxes by taking advantage of the employer plan.
Alternatively, if their AGI was $25,000, Polly and Leo would benefit more by utilizing the credit for
child and dependent care expenses than participating in the dependent care reimbursement plan.
Specifically, such a strategy would generate a credit that would offset the taxes on the $5,000 of
income; in addition, $857 would be available to offset Polly and Leo’s tax liability on their other
income.
Salary $5,000
Income tax rate × 10%
Income tax on salary $ 500
Plus: FICA tax on $5,000 ($5,000 × 7.65%) 383
Total taxes $ 883
Less: Credit for child and dependent care expenses ($5,800 × 30%) (1,740)
Net tax savings ($ 857)
7. (LO 4) Various income exclusions, deductions, and tax credits are available in the tax law to help
make college more affordable, particularly for low- to middle-income taxpayers. Provisions discussed
in the text that provide these benefits include:
• Two education tax credits are available to help offset the cost of a college education: the
American Opportunity credit and the lifetime learning credit.
• Series EE educational savings bonds.
• Qualified tuition programs (§ 529 plans).
• Scholarships.
• The deduction for interest paid on student loans.
• Coverdell Education Savings Accounts (CESAs).
• Penalty-free withdrawals from traditional IRAs to pay for qualifying educational expenses.
8. (LO 5) Kathy’s husband will be subject to FICA, but her daughter will not. Had her daughter been 18
years of age or older, she also would have been subject to FICA.
9. (LO 6) Joan is subject to the Federal self-employment tax on her net earnings from the consulting
business if they are $400 or more for the year. The 2015 self-employment tax is levied at a 13.3% rate
on the first $118,500 of profit; the rate is 2.9% on the profit in excess of this base amount. One-half of
the self-employment tax is allowed as a deduction both (1) in computing the self-employment tax
base and (2) for AGI in computing Joan’s taxable income.
Tax Credits and Payments 12-3
10. (LO 6) For 2015, the self-employment tax applies at a rate of 15.3% on earnings from self-
employment of up to $118,500. In addition, such individuals must pay an additional self-employment
tax at the rate of 2.9% (Medicare) on those earnings in excess of $118,500.
COMPUTATIONAL EXERCISES
11. (LO 2)
Carlson’s general business credit allowed for the tax year is computed as follows.
Net income tax $190,000

Less: The greater of:
Tentative minimum tax $175,000
25% of net regular tax liability that exceeds $25,000
[25% × ($185,000 − $25,000)] $40,000 (175,000)
Amount of general business credit allowed for tax year $15,000
Because the amount of general business credit allowed for tax year is $15,000, Carlson has $69,000
($84,000 − $15,000) of unused general business credits that may be carried back or forward.
12. (LO 3)
a. Emily is entitled to the credit because the building has been substantially rehabilitated
(expenditures exceed the adjusted basis). Emily is allowed a $13,500 (10% × $135,000)
credit for rehabilitation expenditures.
b. If the building was a historic structure, the credit allowed would be $27,000 (20% ×
$135,000).
13. (LO 3) Lincoln Company’s work opportunity credit is $16,800 [($6,000 × 40%) × 7 employees]. If
the tax credit is taken, Lincoln must reduce its deduction for wages paid by $16,800. No credit is
available for wages paid to these employees after their first year of employment.
14. (LO 3)
a. The qualified research expenditures are $117,000 [$60,000 + $5,000 + ($80,000 × 65%)].
b. The incremental research activities credit is $13,400 [($117,000 − $50,000) × 20%].
15. (LO 4)
a. Randy and Rachel are eligible for a $13,400 credit in 2015 (for expenses of $7,000 + $8,000,
limited by the $13,400 ceiling, paid in 2014 and 2015).
b. If Randy and Rachel report AGI of $210,000, the amount of the credit is reduced as follows.
($210,000 − $201,000)/$40,000 = 22.5%.
$13,400 − (22.5% × $13,400) = $10,385.
16. (LO 4) Santiago and Amy can only claim the credit for the children ages 12 and 14. The maximum
child tax credit of $2,000 ($1,000 × 2 children) is reduced because Santiago and Amy ’s AGI is in
excess of the $110,000 threshold. Therefore, the maximum credit must be reduced by $50 for every
$1,000 (or part thereof) above the threshold amount. ($140,000 − $110,000)/$1,000 = 30. The credit
reduction equals $1,500 ($50 × 30). Therefore, the child tax credit is $500 ($2,000 − $1,500).
17. (LO 4) Sergio is deemed to be fully employed and to have earned $500 for each of the nine months
(or a total of $4,500). Because Ivanna and Sergio have AGI of $28,000, they are allowed a credit rate
of 28%. Ivanna and Sergio are limited to $4,500 in qualified child care expenses ($6,000 maximum
expenses, limited to Sergio’s deemed earned income of $4,500). Therefore, they are entitled to a tax
credit of $1,260 (28% × $4,500) for the year.
18. (LO 4) Dante’s tuition is a qualified expense for the American Opportunity credit. For 2015, Paola
and Isidora may claim a $2,500 American Opportunity credit for Dante’s expenses [(100% × $2,000)
+ (25% × $2,000)].
19. (LO 4) The maximum amount of contributions that may be taken into account in calculating the credit
is limited to $2,000 for Rafael and $2,000 for Lucy. As a result, they may claim a credit for their
retirement plan contributions of $800 [($2,000 × 2) × 20%].
20. (LO 5) Bianca’s FICA tax is $7,347 (6.2% × $118,500), and her Medicare tax is $2,378 (2.9% ×
$164,000). The employer must match both of these withheld taxes, which total $9,725.
21. (LO 7) Mario will pay $2,900 of Medicare taxes on the first $200,000 ($200,000 × 1.45%) of his
wages and $5,640 of Medicare taxes on his wages in excess of $200,000 [($440,000 − $200,000) ×
2.35%]. In total, his Medicare tax will be $8,540.
PROBLEMS
22. (LO 2) Charles’s allowable general business credit for the year is limited to $19,000, determined as
follows.
Net income tax $107,000*

Less: The greater of:
$88,000 (tentative minimum tax)
$20,500 [25% × ($107,000 − $25,000)] (88,000)
Amount of general business credit allowed $ 19,000
*Net income tax = $107,000 (regular tax liability) + $0 [alternative minimum tax ($88,000 tentative
minimum tax − $107,000 regular tax liability)] − $0 (nonrefundable credits).
23. (LO 2)
2016 general business credit $36,000
Total credit allowed (based on tax liability) $60,000
Less: Utilization of carryovers on FIFO basis
2012 (5,000)
2013 (15,000)
2014 (6,000)
2015 (19,000)
Remaining credit allowed $15,000
Applied against
2016 general business credit (15,000)
2016 unused amount carried forward to 2017 $21,000
Therefore, the sources of the $60,000 general business credit allowed in 2016 are the carryovers of
$45,000 from the four previous years and $15,000 of the $36,000 general business credit generated in
2016.
Because unused credits may be carried over for up to 20 years, the carryovers from each of the four
previous years may be utilized.
24. (LO 3, 7) Hoffman, Maloney, Raabe, & Young, CPAs

5191 Natorp Boulevard
Mason, OH 45040
September 27, 2015
Mr. Paul Chaing

4522 Fargo Street
Geneva, IL 60134
Dear Mr. Chaing:
This letter is in response to your questions concerning the availability of the rehabilitation tax credit
for expenditures that you plan to incur in the rehabilitation of your qualifying historic structure and
their impact on the cost recovery basis of the structure. It is our understanding that you purchased the
qualifying historic structure for $350,000 (excluding the cost of land) and that you intend to incur
rehabilitation expenditures of either $320,000 or $380,000.
For the credit to be available, the law requires that a taxpayer substantially rehabilitate the structure.
In this case, the requirement calls for you to spend more than $350,000 on rehabilitation charges.
Therefore, if you incurred rehabilitation expenditures of $320,000, the credit would not be available
and the cost recovery basis of the structure would be $670,000 (original cost of $350,000 plus capital
improvements of $320,000).
By incurring $380,000 on rehabilitation expenditures, a credit of $76,000 ($380,000 × 20%) would be

available. However, the cost recovery basis of the property would be reduced to the extent of the
available credit. Therefore, the cost recovery basis of the building would be $654,000 [$350,000
(original cost) plus $380,000 (capital improvements) less $76,000 (amount of credit)].
Because the rehabilitation tax credit is available if you choose the renovation plan costing $380,000
(but not the plan costing $320,000), you need to consider carefully the impact the credit will have on
your short-term cash flow position. Based solely on current cash flow due to the cost of the two
projects and the potential tax credit, you would benefit by selecting the more expensive renovation
project. Although this selection would cost $60,000 more than the less expensive one, you would
benefit from the $76,000 tax credit, for a net cash flow gain of $16,000. Of course other
considerations, including the reduced depreciation deduction associated with the credit, may impact
your decision, but the benefit of the tax credit is indisputable.
Should you need more information or need clarification of our conclusions, please feel free to contact
me.
Sincerely,
Malcolm C. Jones, CPA

Partner
TAX FILE MEMORANDUM
DATE: September 27, 2015
FROM: Malcolm C. Jones, CPA
SUBJECT: Mr. Paul Chaing

Impact of Rehabilitation Tax Credit
Paul Chaing has acquired a qualifying historic structure for $350,000 (excluding the cost of land)
with the intention of substantially rehabilitating the building. He has inquired as to the availability of
the rehabilitation tax credit and its impact on the structure’s cost recovery basis if he incurs either
$320,000 or $380,000 of qualifying rehabilitation expenditures.
To qualify for the rehabilitation credit, Paul must substantially rehabilitate the structure. The substantial
rehabilitation requirement provides that a taxpayer must incur rehabilitation expenditures that exceed the
greater of (1) the adjusted basis of the property before the rehabilitation ($350,000) or (2) $5,000.
Therefore, if Paul chose to incur only $320,000 on the rehabilitation, the amount would not be enough to
qualify as a “substantial rehabilitation” and no credit would be available. The depreciable basis of the
property would be the sum of its original cost plus the capital improvements, or $670,000 ($350,000 +
$320,000).
If Paul incurred $380,000 for the rehabilitation project, a substantial rehabilitation would result.
Therefore, the rehabilitation tax credit available to Paul would be $76,000 ($380,000 × 20%). The
depreciable basis of the property, which would be reduced by the full amount of the credit, would be
$654,000 [$350,000 (original cost) + $380,000 (capital improvements) − $76,000 (amount of credit)].
Although other considerations are likely relevant to Mr. Chaing while he decides which of the two
renovation projects to pursue, certainly the impact of the rehabilitation tax credit on the current cash
flow should not be overlooked. If he decides to undertake the more expensive project (i.e., the one
costing $380,000 rather than the one costing $320,000), the higher cost would be more than offset in
the current year by the benefit he would receive from the tax credit. Thus, the short-term cash flow
advantage would total $16,000 [$76,000 (available tax credit) − $60,000 (incremental cost associated
with the more expensive project)]. Note that this cash flow advantage would be reduced slightly by
the smaller depreciation deduction associated with the credit.
25. (LO 3)
a. The work opportunity tax credit for 2015 is as follows.
3 qualified employees × $6,000 limit on wages for
each employee × 40% $ 7,200
3 qualified employees × $5,000 wages for each
employee × 25% 3,750
Total work opportunity tax credit $10,950
b. The wage deduction for 2015 is $129,050 [$140,000 (total wages) − $10,950 (credit)].
26. (LO 3)
a. Given that the employees are certified as long-term family assistance recipients, the work
opportunity tax credit for 2015 is calculated as follows.
3 qualified employees × $10,000 limit on wages for

each employee × 40% $12,000
The work opportunity tax credit for 2016 is calculated as follows.
1 qualified employee in second year of employment

× $10,000 limit on wages × 50% $5,000
1 qualified employee in first year of employment
× $10,000 limit on wages × 40% 4,000
Total work opportunity tax credit $9,000
b. The wage deduction for 2015 is $313,000 [$325,000 (total wages) − $12,000 (credit)]. The
wage deduction for 2016 is $333,000 [$342,000 (total wages) − $9,000 (credit)].
27. (LO 3, 7)
a. Qualified research expenditures for the year $40,000
Less: Base amount (32,800)
Incremental research expenditures $ 7,200
Tax credit rate × 20%
Incremental research activities credit $ 1,440
b. The tax benefit of Tom’s choices is determined as follows.
Choice 1: Reduce the deduction by 100% of the credit, and claim the full credit.
$40,000 (qualified expenditures) − $1,440 (credit) $38,560

Tax rate × 25%
Tax benefit of reduced deduction $ 9,640
Plus: Allowed credit 1,440
Total tax benefit of Choice 1 $11,080
Choice 2: Claim the full deduction, and reduce the credit by the product of 100% of the credit
times 35% (the maximum corporate rate).
Deduction (qualified expenditures) $40,000

Tax rate × 25%
Tax benefit of full deduction $10,000
Plus: Reduced credit: $1,440 − [(100% × $1,440) × 35%] 936
Total tax benefit of Choice 2 $10,936
Thus, Choice 1 provides Tom a greater tax benefit of $144 ($11,080 − $10,936).
28. (LO 3) Hoffman, Maloney, Raabe, & Young, CPAs

5191 Natorp Boulevard
Mason, OH 45040
September 29, 2015

Mr. Ahmed Zinna
16 Southside Drive
Charlotte, NC 28204
Dear Mr. Zinna:
This letter is in response to your inquiry regarding the tax consequences of the proposed capital
improvement projects at your Calvin Street and Stowe Avenue locations.
As I understand your proposal, you plan to incur certain expenditures that are intended to make your
stores more accessible to disabled individuals in accordance with the Americans with Disabilities Act.
The capital improvements that you are planning (e.g., ramps, doorways, and restrooms that are
handicap-accessible) qualify for the disabled access credit if the costs are incurred for a facility that
was placed in service before November 6, 1990. Therefore, only those projected expenditures of
$8,500 for your Stowe Avenue location qualify for the credit.
The credit is calculated at the rate of 50% of the eligible expenditures that exceed $250 but do not
exceed $10,250. Thus, the maximum credit in your situation would be $4,125 [($8,500 − $250) ×
50%]. You should also be aware that the basis for depreciation of these capital improvements would
be reduced to $4,375, the amount of the expenditures of $8,500 reduced by the amount of the disabled
access credit of $4,125. The capital improvements that you are planning for your Calvin Street
location, even though they do not qualify for the disabled access credit, may be depreciated.
Should you need more information or need to clarify the information in this letter, please call me.
Sincerely,
Raymond Cook, CPA

Partner
29. (LO 3) The allowed credit is [50% × ($7,500 − $250)] = $3,625. The depreciable basis of the
improvements is reduced by this amount.
30. (LO 3) The allowed credit is 10% × $15,000 = 1,500.
31. (LO 4)
a. Thomas is not eligible for the earned income credit because he does not have a qualifying
child and is not between the ages of 25 and 64.
b. Shannon is eligible for the earned income credit because she has a qualifying child. Because
her earned income and AGI are below the income level where the earned income credit
begins to phase out ($18,110 in 2015), Shannon qualifies for the maximum earned income
credit.
c. Keith and Susan are not eligible for the earned income credit because they do not have a
qualifying child and their income exceeds the disqualifying threshold for the credit that is
available when there is no qualifying child ($20,330 in 2015).
d. Even though Colin does not have a qualifying child, he is eligible for the earned income
credit because he is between 25 and 64 years of age, cannot be claimed as a dependent on
another taxpayer’s return, and has earnings below the level at which the credit is completely
phased out ($14,820 in 2015).
32. (LO 4, 7) Cooper’s alternatives as to its foreign tax payments are as follows.
• Deduct $2.5 million in foreign taxes in computing taxable income, or
• Deduct the $1.5 million value-added tax (VAT) and use the $1 million income tax payment in
computing a foreign tax credit (FTC).
The $1 million income tax can be split in any manner between the credit and deduction. Usually, the
credit is more advantageous for the taxpayer. An FTC is not allowed for non-income taxes such as the
VAT.
33. (LO 4) The Jimenez foreign tax credit (FTC) for the year is computed as follows.
FTC = Lesser of:
• Foreign tax imposed $1 million, or
• FTC overall limitation = U.S. Federal income tax paid on the overseas profits = 35% × $5 million
= $1,750,000
Thus, a current $1 million FTC is allowed. All of the foreign tax payments have been recovered by
Jimenez, so no FTC carryover is created.
34. (LO 4) The Jimenez foreign tax credit (FTC) for the year is computed as follows.
FTC = Lesser of:
• Foreign tax imposed $2 million, or
• FTC overall limitation = U.S. Federal income tax paid on the overseas profits = 35% × $5 million
= $1,750,000
Thus, a current $1,750,000 FTC is allowed. The unused $250,000 foreign tax credit is carried back
1 year and then forward 10 years by Jimenez.
35. (LO 4)
a. Ann and Bill must claim the adoption expenses credit in 2015 ($5,000 + $11,000, limited to
$13,400) because they paid or incurred qualified adoption expenses prior to the year in which
the adoption was finalized and in the year finalized. In their particular case, they may take the
credit in 2015 for $13,400. The amount of expenses paid in excess of $13,400 is a
nondeductible personal expense. Further, because their modified AGI is less than $201,010,
the amount of the credit otherwise available is not reduced.
b. $7,038 = $13,400 − {$13,400 × [($220,000 − $201,010) ÷ $40,000]}.
36. (LO 4)
a. Durell and Earline may claim the child tax credit for their two children, ages 5 years and 6
months. The full amount of the child tax credit is available for qualifying children born during
the tax year. Although Earline’s son from a previous marriage is claimed as a dependent, he is
not eligible for the child tax credit because he is not under age 17. Because Durell and
Earline’s combined AGI is below $110,000, their child tax credit is $2,000 ($1,000 × 2).
b. Because Durell and Earline’s combined AGI exceeds $110,000, the maximum child tax credit
of $2,000 must be reduced. The credit reduction is computed as $50 for each $1,000 of AGI
or fraction thereof exceeding the threshold amount.
AGI $122,000
Threshold amount (110,000)
Excess $ 12,000
$12,000
× $50 = $600 reduction.
$1,000
Durell and Earline’s child tax credit is $1,400 ($2,000 maximum credit − $600 reduction) for
the year.
37. (LO 4) For two or more children, the maximum expense allowed for purposes of the credit for child
and dependent care expenses is $6,000. Actual child care expenses ($3,800) are less than this ceiling
and lower than Karen’s earned income of $9,000 (the spouse with the lesser earned income). Because
their combined AGI is more than $43,000, the applicable rate for the credit is 20%. Thus, the credit
allowed is $760 (20% × $3,800).
38. (LO 4) For two or more children, the maximum expense allowed for purposes of the credit for child
and dependent care expenses is $6,000. However, because the qualifying expenditures are limited to
the earnings of the spouse with the lesser earned income (i.e., $5,200), this amount is used in
calculating the credit. Using the combined AGI of $21,200 ($16,000 + $5,200), the applicable rate for
the credit is 31%. Thus, the credit is $1,612 (31% × $5,200).
The fact that the care was provided by Jim’s mother is of no consequence because she is not Jim and
Mary Jean’s child.
39. (LO 4, 7)
a. Bernadette is eligible to take the American Opportunity credit for her son’s tuition costs and
books and for the lifetime learning credit for the tuition expenses for her continuing
professional education seminars. The costs for books incurred by Bernadette are ineligible for
the credit. As Bernadette’s AGI ($112,000) is less than $160,000, Bernadette qualifies for a
$2,500 American Opportunity credit. The lifetime learning credit is available per taxpayer on
the first $10,000 of qualifying tuition expenses. Accordingly, her tuition ($2,000) would
qualify for the credit during 2015. Therefore, Bernadette’s maximum lifetime learning credit
would be $400 (20% × $2,000) for 2015. However, the $400 maximum credit would have to
be reduced by $40 because her $112,000 AGI exceeds the threshold level of $110,000 for
married taxpayers.
[($112,000 − $110,000)/$20,000] × $400 = $40 reduction
Maximum credit $400

Less: Phaseout (40)
Lifetime learning credit $360
Bernadette’s total education credits amount to $2,860 (American Opportunity credit of

$2,500 plus lifetime learning credit of $360). The portion of the costs associated with the
continuing education seminars that are not used in the lifetime learning credit calculation may
qualify as employee business expenses, deductible as education expenses.
b. “How Can the Tax Law Help Pay for College and Continuing Professional Education?”
Outline for Presentation to Rotary Club
I. Introduction.
A. Many tax provisions are available to help defray the cost of both college and
continuing professional education.
B. Complicated area of tax law, so planning ahead is important.
II. Tax provisions that help pay for college.
A. Contributions to Coverdell Educational Savings Accounts (CESAs).
B. Penalty-free withdrawals to pay for college from traditional IRAs.
C. Participation in qualified tuition programs for tuition and room and board costs.
D. Deductibility of student-loan interest.
E. Purchase of Series EE educational savings bonds.
F. Education tax credits—American Opportunity credit and lifetime learning credit.
G. Employer-provided educational assistance programs.
H. Scholarships exempt from taxation.

I. The limited deduction for qualified tuition and related expenses (if extended by
Congress).
III. Tax provisions that help pay for continuing education.
A. Lifetime learning credit.
B. Employer-provided educational assistance programs.
C. Deductibility of expenses ineligible for credit or assistance program.
IV. Income limitations and interaction among various provisions also are important issues.
40. (LO 4)
a. Kathleen and Glenn’s contributions to their respective § 401(k) plans are qualified
contributions; however, the maximum amount that may be considered in calculating the credit
is $2,000 for each taxpayer. In addition, because their AGI is $35,000, the rate of the credit is
50%. Therefore, the credit available to Kathleen and Glenn is $2,000 [($2,000 × 2) × 50%].
b. Joel may not claim the credit for certain retirement plan contributions because he is less than
18 years of age and is claimed as a dependent on his parents’ return.
TAX RETURN PROBLEM
41. Part 1—Tax Computation
Gross income:
Salary $65,000
Interest income ($1,300 + $400) 1,700
Dividend income ($800 + $750 + $650) 2,200
State income tax refund 1,100
Business income (Note 1) 19,800
Net STCG (Note 2) 1,200
Total gross income $91,000
Deductions for AGI:
Business expenses (Note 1) (16,750)
Self-employment tax deduction (Note 3) (216)
Adjusted gross income $74,034
Deductions from AGI:
Itemized deductions (Note 4) (9,834)
Personal exemption (3,950)
Taxable income $60,250
Income tax (Note 5) $10,705
Self-employment tax (Note 3) 431
Total tax $11,136
Taxes withheld (10,500)
Estimated taxes (1,000)
Net tax payable (or refund due) for 2014 ($ 364)
See the tax return solution beginning on p. 12-20 of the Solutions Manual.
Notes
(1) Business receipts
Part-time tax practice revenues $ 3,800
Sale of software program 16,000
Business expenses
Part-time tax practice processing fees $ 600
Software development business ($7,000 + $2,000 + $3,000 +
$650 + $3,500) 16,150
Total business expenses (deducted for AGI) $16,750
(2) Gray stock ($7,000 − $8,800) STCL ($ 1,800)

Utility vehicle ($6,500 − $6,000) STCG 500
Blue stock ($5,500 − $3,000) STCG 2,500
Net STCG $ 1,200
(3) Beth’s earnings from self-employment during 2014 were $3,050 ($19,800 − $16,750), and
the self-employment tax on this amount is computed as follows.
Social Security Medicare

Portion Portion
Ceiling amount $117,000
Less: FICA wages (65,000)
Net ceiling $ 52,000
Net self-employment income ($3,050 × 92.35%) $ 2,817 $2,817
Lesser of net ceiling or net self-employment income* $ 2,817 $2,817

Tax rate × 12.4% × 2.9%
Self-employment tax $ 349 $ 82
Total self-employment tax $431
Beth’s for AGI self-employment tax deduction is $216 ($431 × 50%).
*All of Beth’s net self-employment earnings are subject to both portions of the self-
employment tax.
(4) Medical expenses [($300 + $2,875) − (10% × $74,034)] $ –0–

Taxes ($1,954 + $1,766) 3,720
Home mortgage interest 3,845
Charitable contributions ($1,560 + $520) 2,080
Miscellaneous itemized deductions
Professional dues and subscriptions $ 350
Convention expenses, excluding meals 1,220
Meals ($200 × 50%) 100
$1,670
Less: 2% of AGI ($74,034 × 2%) (1,481) 189
Itemized deductions $9,834
(5) Tax on taxable income of $60,250

Tax on dividend income ($2,200 × 15%) $ 330
Tax from Tax Table on remaining taxable
income of $58,050 ($60,250 − $2,200) 10,375
Total income tax $10,705
Part 2—Tax Planning

Gross income:
Salary $65,000
Interest income ($1,300 + $400) 1,700
Dividend income ($800 + $750 + $650) 2,200
State income tax refund 1,100
Net STCG 1,200
Deductions for AGI (–0–)
Itemized deductions
Medical expenses
[($300 + $2,875) − (10% × $71,200)] $ –0–
Taxes ($1,954 + $1,766) 3,720
Home mortgage interest 3,845
Charitable contributions ($1,560 + $520) 2,080
Miscellaneous itemized deductions
Professional dues and subscriptions $ 350
Convention expenses, excluding meals 1,220
Meals ($200 × 50%) 100
$1,670
Less: 2% of AGI ($71,200 × 2%) (1,424) 246
Total itemized deductions (9,891)
Personal exemptions ($4,000 × 2) (8,000)
Income tax for 2015 (based on the head-of-household rate
schedule) (Note 1) $ 7,430
Less: Child tax credit $1,000
Credit for child and dependent care expenditures ($3,000 × 20%) 600
Adoption expenses credit 2,000 (3,600)
Less: Income taxes withheld (10,500)
Net tax payable (or refund due) for 2015 ($ 6,670)
With such a substantial refund due based on these assumptions, Beth should revise her Form W–4 so
that a smaller amount of Federal income tax will be withheld from her salary in 2015.
Note
(1) Tax on $51,109 ($53,309 − $2,200) $7,100
Tax on $2,200 ($2,200 × 15%) 330
Total income tax $7,430
42. Tim’s net business ($325,000 − $201,000) $124,000

Sarah’s salary 145,000
Interest income 7,000
Gross income $276,000
Less: Deductions for AGI
Capital losses (Note 1) $ 3,000
Self-employment tax deduction (Note 5) 8,760 (11,760)
Less: Itemized deductions (Note 2) (27,900)
Personal and dependency exemptions (Tim, Sarah,
Sean, and Debra) (Note 3) (16,000)
Computation of net tax payable or refund due

Tax from Tax Rate Schedule on $220,340 (Note 4) $ 48,747
Plus: Self-employment tax (Note 5) 17,521
Total tax $ 66,268
Less: Prepayments and credits
Income tax withheld $31,850
Estimated tax payments 34,000
Credit for child and dependent care
expenses (Note 6) 600 (66,450)
Net tax payable (or refund due) ($ 182)
Notes
(1) Capital asset transactions:
Short-term capital loss ($9,800 − $12,000) ($2,200)
Long-term capital loss ($3,800 – $5,000) ( 1,200)
Total capital loss ($3,400)
Capital loss deduction limitation ($3,000)
(2) Itemized deductions $27,900

Plus: Miscellaneous itemized deductions:
Travel expenses excluding meals $ 900
Meals and entertainment ($700 × 50%) 350
$1,250
Limited to excess over 2% of AGI:
(2% × $264,240 = $5,285) (5,285) –0–
Itemized deductions $27,900
Note: The overall limitation on itemized deductions does not apply because AGI does not
exceed $309,900.
(3) Personal and dependency exemptions ($4,000 × 4) $16,000
Note: The exemption phaseout does not apply because AGI does not exceed $309,900.
(4) Tax Computation (Taxable income of $220,340; Married, filing jointly):

Tax on $151,200 $29,387.50
Tax on $69,140 ($220,340 − $151,200) at 28% 19,359.20
Total income tax $48,746.70
(5) The net earnings from self-employment are $124,000 ($325,000 − $201,000). Therefore, the
self-employment tax is computed as follows.
(1) Net earnings from self-employment $124,000

(2) Multiply line (1) by 92.35% $114,514
(3) If the amount on line 2 is $118,500 or less, multiply the line 2
amount by 15.3%. This is the self-employment tax. $17,520.64
(4) If the amount on line 2 is more than $118,500, multiply the
excess of line 2 over $117,000 by 2.9% and add $18,130.50.
This is the self-employment tax.
In 2015, the deduction for AGI is $8,760.32 ($17,520.64 × 50%).
(6) The credit for child and dependent care expenses is limited to 20% of $3,000 (the maximum
credit for one child), or $600. The 16-year-old child does not qualify due to the under age 13
limitation.
RESEARCH PROBLEMS
1. Ashby and Curtis will not be able to claim the credit for child and dependent care expenses for the
nursery school tuition because the credit is available only to taxpayers who incur employment-related
expenses for child and dependent care. Even though nursery school expenditures incurred on behalf
of a 2-year old child normally would qualify as child care, the expenditures are not “employment-
related” because Ashby’s activities at the art studio do not constitute a trade or business. Reg.
§ 1.44A–1(c)(1)(i) provides that expenses will not be treated as employment-related unless they are
incurred to enable the taxpayer to be gainfully employed (or to actively search for gainful
employment). In a case with facts similar to Ashby and Curtis’s (Hollander T.C.Memo. 1975–157, 34
TCM 718), nursery school expenditures incurred that enabled the taxpayer to pursue her painting,
were not employment-related because the painting was a hobby, not a trade or business.
2. Based on the facts of this case, the primary issue is whether Miriam may move a structure from its
original location, incur rehabilitation expenditures, and still claim the tax credit for rehabilitation
expenditures. In order to claim the credit, qualified expenditures have to be made with respect to a
qualified building. Section 47(c)(1)(A)(iii) stipulates that a qualified building is one where specified
portions of exterior and interior walls are “retained in place” in the rehabilitation process. Regulation
§ 1.48-12(b)(5) states that, with respect to the “ retained in place” requirement, “a building, other than
a certified historic structure, is not a qualified rehabilitated building unless it has been located where
it is rehabilitated since before 1936…” In other words, this Regulation states that a building that is
relocated prior to its rehabilitation does not constitute a qualified rehabilitated building because it has
not been retained in place. Therefore, it would seem that Miriam would not be allowed to claim the
tax credit for rehabilitation expenditures if she moved the building from its original location.
In a similar fact pattern [George S. Nalle, III, 99 T.C. 187 (1992)], the Court upheld the validity of
this Regulation by claiming that the Secretary correctly gauged the congressional intent for the
rehabilitation credit to be a means of stemming inner city blight. In the Court’s view, that statute was
never intended to benefit taxpayers who relocated a building prior to making renovations, as there
would be no benefit to the communities from which the building were removed. However, in the
appeal of this case [93-2 USTC ¶ 50,465, 72 AFTR2d 93-5705, 997 F.2d 1134 (CA-5, 1993)], the
denial of the credit was reversed. The Fifth Circuit concluded that Regulation § 1.48-12(b)(5) was an
invalid interpretation of Section 47(c)(1)(A)(iii) because the statute was unambiguous and contained
no such exclusion or restrictions regarding relocation. Essentially, the Court felt that the impact of the
Regulation went beyond the intent of Congress. Therefore, based on the statute and its interpretation,
Miriam will be able to benefit by claiming the rehabilitation credit and, as a result, will pursue the
purchase, relocation, and renovation of the house.
Research Problems 3 to 5
The Internet Activity research problems require that students utilize online resources to research and answer
the questions. As a result, solutions may vary among students and courses. You should determine the skill and
experience levels of the students before assigning these problems, coaching where necessary. Encourage
students to explore all parts of the Web in this research process, including tax research databases, as well as
the websites of the IRS, newspapers, magazines, businesses, tax professionals, other government agencies,
and political outlets. Students should also work with resources such as blogs, Twitter feeds, and other
interest-oriented technologies to research their answers.
3. The calculator can be found here:
http://apps.irs.gov/app/eitc2013/SetLanguage.do?lang=en
4. See the Internet Activity comment above.
5. See the Internet Activity comment above.
CHECK FIGURES
11. $15,000. 27.a. $1,440.

12.a. $13,500. 27.b. Taking the reduced deduction and the full
12.b. $27,000. credit provides the greater benefit.
13. $16,800. 28. Credit available of $4,125.
14.a. $117,000. 29. $3,625.
14.b. $13,400. 30. $1,500.
15.a. $13,400. 31.a. Not eligible.
15.b. $10,385. 31.b. Eligible.
16. $500. 31.c. Not eligible.
17. $1,260. 31.d. Eligible.
18. $2,500. 33. $1,000,000 FTC.
19. $800. 34. $1,750,000 FTC allowed,
20. $7,347; $2,378. $250,000 carryover.
21. $8,450. 35.a. $13,400.
22. $19,000. 35.b. $7,038.
23. Credit allowed $60,000; credit carried 36.a. $2,000.
forward $21,000. 36.b. $1,400.
24. With a $380,000 expenditure: the credit 37. $760.
equals $76,000, depreciable basis of 38. $1,612.
building equals $654,000. 39.a. $2,860.
25.a. $10,950. 40.a. Credit available $2,000.
25.b. $129,050. 40.b. May not claim credit.
26.a. 2014 $12,000; 2015 $9,000.
26.b. 2014 $313,000; 2015 $333,000.
SOLUTIONS TO ETHICS & EQUITY FEATURES
The Rehabilitation Tax Credit (p. 12-7). A potential customer who is interested in buying real property has
approached the taxpayer’s brother. The taxpayer’s brother has been asked to renovate the building subsequent
to its sale—with the renovations qualifying the buyer for the rehabilitation tax credit. The potential buyer has
asked the seller to reduce the sales price by $50,000 and has promised to pay $50,000 more for the renovation
work. The buyer appears to have made this request so that he or she can receive the tax benefits of qualifying
for the rehabilitation tax credit.
The issue is whether it is appropriate for the sales contract and the construction contract for the buyer to
reflect amounts different from those the taxpayer normally would expect (i.e., $50,000 lower for sales
contract and $50,000 higher for construction contract).
The problem states that based on several appraisals, the building is worth about $400,000. Because this
amount is based on a range of appraised values, the taxpayer should examine them. Although the normal
selling price for the building is approximately $400,000 and the normal price for the rehabilitation project is
approximately $250,000, selling the building and renovation as part of a package deal may provide some
justification for different prices for the different components.
It does appear, however, that the motivation of the buyer for the different allocations is tax avoidance (i.e., to
qualify for a larger rehabilitation tax credit). Some questions to ask:
• Would the taxpayer sell the building for $350,000 without the promised rehabilitation project?
• Would the taxpayer be able to charge anyone else $300,000 for the rehabilitation project?
• What is the range of values identified by the appraisals? If $350,000 is outside this range, then it would be
difficult to support the sale of the building at this price.
Although the taxpayer’s brother would like to sell the building and complete the renovations, he must have
the documents that support the sales price and renovation costs.
Holding on to the Earned Income Credit with the Aid of a Transient Child (p. 12-15). Rearranging the
residence of Loretta’s grandchild is not an unethical solution under these circumstances. As long as the
grandchild lives for more than half the year in a household where Loretta provides most of the financial
support, the earned income credit will be retained. Documentation of the living arrangements here should be
detailed. Other grandchildren can help to qualify other parties (e.g., the parent of the minor) for the credit as
well.
Using the Credit for Child and Dependent Care Expenses (p. 12-20). Bob and Carol have asked Dolores
to stay at their house after Bob returns from work for the sole purpose of cleaning their house (i.e., not to
provide child care to enable either spouse to work outside the home). If your intuition indicated a problem
with Bob and Carol’s plans, your intuition is correct: Bob and Carol’s idea appears to be inconsistent with the
law. As a result, these incremental expenses should not qualify for the child and dependent care credit.
Expenses will not qualify for the credit unless they are incurred to enable the taxpayer to be gainfully
employed [Reg. § 1.44A–1(c)(1)(i)]. Housecleaning expenses incurred while being gainfully employed do not
satisfy the above requirement where they are incurred to make life easier for the fully employed taxpayer and
to allow him or her to spend the time required for housecleaning in more enjoyable pursuits (Knutson, 60
TCM 540, T.C. Memo. 1990–440).
Based on Bob and Carol’s circumstances, it would appear that their plan of hiring Dolores for additional
hours would be to allow them to avoid housecleaning work in pursuit of more enjoyable activities (rather than
permitting gainful employment). Therefore, if they were to aggregate the additional charges with the
legitimate child care costs on their income tax return, while the government may never become aware of the
circumstances, the treatment would be inappropriate.
However, Bob and Carol might be able to comply with the “letter and spirit” of the law if they were to have
Dolores perform the housecleaning for additional pay during the present child care time period (while Bob
and Carol are at work).
SOLUTIONS TO ROGER CPA REVIEW QUESTIONS
Detailed answer feedback for Roger CPA Review questions is available on the instructor companion site
(www.cengage.com/login).
1. b 5. d
2. b 6. c
3. d 7. d
4. a
41.
41. continued
41. continued
41. continued
41. continued
41. continued
41. continued
41. continued
41. continued
41. continued
41. continued
41. continued
41. continued

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Comprehensive 39th Edition Hoffman

TAX CREDITS AND PAYMENTS

SOLUTIONS TO PROBLEM MATERIALS

Net income tax $190,000

b. The incremental research activities credit is $13,400 [($117,000 − $50,000) × 20%].

($210,000 − $201,000)/$40,000 = 22.5%.

$13,400 − (22.5% × $13,400) = $10,385.

Net income tax $107,000*

24. (LO 3, 7) Hoffman, Maloney, Raabe, & Young, CPAs

September 27, 2015

Mr. Paul Chaing

Dear Mr. Chaing:

By incurring $380,000 on rehabilitation expenditures, a credit of $76,000 ($380,000 × 20%) would be

Malcolm C. Jones, CPA

TAX FILE MEMORANDUM

DATE: September 27, 2015

FROM: Malcolm C. Jones, CPA

SUBJECT: Mr. Paul Chaing

3 qualified employees × $10,000 limit on wages for

The work opportunity tax credit for 2016 is calculated as follows.

1 qualified employee in second year of employment

b. The tax benefit of Tom’s choices is determined as follows.

$40,000 (qualified expenditures) − $1,440 (credit) $38,560

Deduction (qualified expenditures) $40,000

28. (LO 3) Hoffman, Maloney, Raabe, & Young, CPAs

September 29, 2015

Dear Mr. Zinna:

Raymond Cook, CPA

30. (LO 3) The allowed credit is 10% × $15,000 = 1,500.

• Deduct $2.5 million in foreign taxes in computing taxable income, or

FTC = Lesser of:

• Foreign tax imposed $1 million, or

FTC = Lesser of:

• Foreign tax imposed $2 million, or

b. $7,038 = $13,400 − {$13,400 × [($220,000 − $201,010) ÷ $40,000]}.

[($112,000 − $110,000)/$20,000] × $400 = $40 reduction

Maximum credit $400

Bernadette’s total education credits amount to $2,860 (American Opportunity credit of

H. Scholarships exempt from taxation.

TAX RETURN PROBLEM

41. Part 1—Tax Computation

(2) Gray stock ($7,000 − $8,800) STCL ($ 1,800)

Social Security Medicare

Net self-employment income ($3,050 × 92.35%) $ 2,817 $2,817

Lesser of net ceiling or net self-employment income* $ 2,817 $2,817

Beth’s for AGI self-employment tax deduction is $216 ($431 × 50%).

(4) Medical expenses [($300 + $2,875) − (10% × $74,034)] $ –0–

(5) Tax on taxable income of $60,250

Part 2—Tax Planning

42. Tim’s net business ($325,000 − $201,000) $124,000

Computation of net tax payable or refund due

Capital loss deduction limitation ($3,000)

(2) Itemized deductions $27,900

Itemized deductions $27,900

(3) Personal and dependency exemptions ($4,000 × 4) $16,000

(4) Tax Computation (Taxable income of $220,340; Married, filing jointly):

(1) Net earnings from self-employment $124,000

3. The calculator can be found here:

4. See the Internet Activity comment above.

5. See the Internet Activity comment above.

11. $15,000. 27.a. $1,440.

SOLUTIONS TO ETHICS & EQUITY FEATURES

SOLUTIONS TO ROGER CPA REVIEW QUESTIONS