End of Chapter Problems
Total Page：16
File Type：pdf, Size：1020Kb
CHAPTER 6 END OF CHAPTER PROBLEMS
Discussion Questions
1. Discuss the definition of a trade or business. Why does it matter whether a taxpayer is classified as an employee or self-employed?
Answer: A trade or business is any activity that is engaged in for profit continually and regularly. The income from a sole proprietor is netted with related ordinary and necessary business expenses to determine the effect on AGI.
2. Discuss the concepts of ordinary, necessary, and reasonable in relation to trade or business expenses.
Answer: According §162, in order for an expense to be deductible it must be an ordinary and necessary expenditure. The expense must also be reasonable (as established by the courts). A trade or business expense must not only be ordinary and necessary but also reasonable in amount and reasonable in relation to its purpose. The Supreme Court (in Welch , T., 1933, S Ct, 290 US 111) held that in order for an expense to be ordinary, in must be customary or usual in the taxpayers particular business. The necessary criterion refers to an expense that is appropriate and helpful, and not necessarily essential to the taxpayer’s business. Reasonableness is not specifically included by IRC §162, but has been added by the courts. In these cases, the courts held that a trade or business expense must not only be ordinary and necessary but also reasonable in amount and reasonable in relation to its purpose.
3. What form is depreciation reported on and how does it relate to other forms such as Schedule C, E, F, and Form 2106?
Answer: Depreciation is the expense allowed for the wear or loss of usefulness of a business asset. The understanding of depreciation is extremely important aspect of the tax system because depreciation is a material non-cash expense. Depreciation is allowed on most assets (excluding land) used in a trade or business or any activity held for the production of income (e.g. rental property). Thus, the depreciation calculation affects nearly every aspect of a tax return of any complexity.
6-1 4. On what type of property is depreciation allowed?
Answer: Depreciation is allowed on trade or business property including (but not limited to) buildings, race horses, breeding hogs, automobiles, railroad tracks, sawmill equipment, water transportation equipment, wastewater treatment plants, roads, land improvements. An exhaustive list of depreciable property can be found in IRC §168(e).
5. Discuss the word basis in relation to the financial accounting term book value. What is meant by the term adjusted basis?
Answer: Basis is similar to book value. Typically, the depreciable basis of property is the initial cost of the property. Adjusted basis is the cost basis less any accumulated depreciation.
6. Discuss the difference between personal property and real property. Give examples of each.
Answer: Real property consists of land and buildings as well as any other structural components attached to land. Personal property includes equipment, furniture, and fixtures, or anything else that is not classified as real property.
7. What is a depreciation convention? What conventions are available under MACRS?
Answer: A depreciation convention is a concept, which is used to determine the amount of a partial year allowed in the depreciation calculation. Available conventions include the half-year convention, the mid-quarter convention, and the mid-month convention.
8. When calculating depreciation for personal property (assuming the half-year convention) using the IRS depreciation tables, does the taxpayer need to multiply the first year depreciation by one-half? What about in the year of disposal assuming the property is disposed of prior to the end of its recovery period?
Answer:
6-2 The half-year convention for the first year is built into the depreciation tables issued by the IRS. However, in the year of disposal, the table percentage must be multiplied by ½ for the half-year convention and the appropriated months for mid-quarter and mid-month conventions.
9. Discuss the concept of electing §179 expense. Does the election allow a larger expense deduction in the year of asset acquisition?
Answer: The taxpayer can elect to expense a certain portion of personal property purchased during the year (the election cannot be made for real property.) The maximum yearly deduction is determined in §IRC 179(b)(1). The expense election is phased out dollar-for-dollar for purchases in excess of $430,000. Unused §179 deductions cannot be carried forward unless the expense is disallowed by the lack of business income.
10. Discuss the concept of listed property.
Answer: Listed property is defined as any passenger automobile or other property used as a means of transportation, property used for entertainment (boat), computer or peripheral equipment, or any cellular telephone or other telecommunications equipment.
11. Distinguish between travel and transportation expenses.
Answer: Travel expenses are different from transportation expenses in that travel involves the overnight stay for business purposes. The basic travel requirement is that the trip requires sleep or rest.
12. When can a taxpayer use the standard mileage rate? Is the standard mileage rate better than the actual auto costs?
Answer: A taxpayer can use the standard mileage rate if the taxpayer owns the vehicle and uses the standard mileage rate for the first year it was placed in service or if the auto is leased, the standard mileage rate must be used for the entire lease period. The actual expense method usually results in a larger deduction but also requires receipts for actual expenses, as well as a mileage log to determine business use verses personal use.
6-3 13. Discuss the limits on meals and entertainment. Are meal and entertainment expenses always limited to 50%?
Answer: Generally, any business meals and entertainment expenditures are limited to 50% of the amount incurred. The 50% limit pertains to any expense for food or beverage and to any expense with respect to an activity that is generally considered to constitute entertainment, amusement, or recreation. To qualify for any deduction, meal and entertainment expenses must be both ordinary and necessary business expenses as well as be either directly related or associated with business. Directly related or associated with business primarily means that the activity took place in a business setting or the entertainment directly preceded or followed business discussions.
14. Discuss the limits on home office expense deductibility.
Answer: Home-office expenses that would not be otherwise deductible (such as insurance, utilities, and depreciation) are limited to the gross income from the business use of the home. The gross income is first reduced by regular trade or business expenses (not related to the home) and home office expenses that would be deductible in any event (mortgage interest and property taxes). If any positive income remains, the business use portions of insurance, utilities, and depreciation (depreciation is used last) can be deducted.
15. Why were the hobby loss rules established? What factors determine whether an activity is a trade or business or a hobby? Is any one factor controlling?
Answer: Congress established the hobby loss rules in order to limit deductible losses from activities that are primarily for personal pleasure instead of a trade or business. Some of the factors that determine whether an activity is to be considered a hobby or a trade or business include the manner in which the taxpayer carries on the activity, the expertise of the taxpayer or his advisors, the time and effort expended by the taxpayer in carrying on the activity, the expectations that assets used in the activity may appreciate in value, the success of the taxpayer in carrying on other similar or dissimilar activities, the taxpayer’s history of income or losses with respect to the activity, the amount of occasional profits, if any, which are earned, the financial status of the taxpayer, and whether the activity creates elements of personal pleasure or recreation. All the facts and circumstances are to be taken into account and no one factor is determinative in the hobby determination.
6-4 16. What are the two components of the self-employment tax? Is either component limited?
Answer: Self-employment tax consists of two parts, the social security tax and the Medicare tax. The tax base for the social security tax is limited. In tax year 2006, only the first $94,200 of wages and self-employment income is subject to the social security tax. The Medicare tax is not limited.
Multiple Choice
17. Trade or business expenses are treated as: a. A deduction for AGI. b. An itemized deduction if not reimbursed. c. A deduction from AGI. d. A deduction from AGI limited to the amount in excess of 2% of AGI.
Answer: a
18. Which of the following is not a “trade or business” expense? a. Interest on investment indebtedness. b. Property taxes on business equipment. c. Depreciation on business property. d. Cost of goods sold.
Answer: a
19. Farrah, an attorney, had the following income and expenses in her business:
Fee income $200,000 Expenses: Fees paid to ambulance crews for referrals (legal under state law) 15,000 Fees paid to CPAs for referrals (illegal under state law) 8,000 Office expenses 5,000
5,000 Supplies 3,000 Business long distance phone charges 1,000 Tickets for illegal parking 900
6-5 How much net income must Farrah report from this business? a. $167,100. b. $175,100. c. $176,000. d. $191,000.
Answer: c
20. Edith, a CPA, flew from Miami to San Diego to attend an accounting conference that lasted five days. Then she took four days of vacation to go sightseeing. Edith’s expenses for the trip are as follows:
Air fare $725 Lodging (9 days × $165) 1,485 Meals (9 days × $80) 720 Taxi from airport to hotel and back 60
Edith’s travel expense deduction is: a. $1,810. b. $2,010. c. $2,630. d. $2,990.
Answer: a
21. On May 5, 2003, Jill purchased equipment for $20,000 to be used in her business. She did not elect to expense the equipment under § 179. On December 15, 2006, she sells the equipment to a scrap metal dealer. What is the cost recovery deduction for 2006? a. $0. b. $1,249. c. $2,498. d. $8,746.
Answer: b. Fourth year of depreciation of a seven year asset with one-half year in the year of disposal.
22. On April 15, 2004, Andy purchased some furniture and fixtures (7-year property) for $10,000 to be used in his business. He did not elect to expense the equipment under §179 or bonus depreciation. On June 30, 2006, he sells the equipment. What is the cost recovery deduction for 2006? $ 0. $ 875. $1,429. $1,749.
6-6 Answer: b
23. Don purchased an office building on March 30, 2006 for $250,000, $25,000 of which was for the land. What is the cost recovery deduction for 2006? a. $0. b. $3,621. c. $4,574. d. $5,083.
Answer: c
24. Roy purchased an office building on March 30, 2003 for $250,000. $25,000 of the price was for the land. On July 30, 2006, he sold the office building. What is the cost recovery deduction for 2006? a. $0. b. $3,125. c. $5,769. d. $6,410.
Answer: b. Fourth year, 6.5 months.
25. On June 30, 2006, Ken purchased an apartment building for $500,000. Determine the cost recovery deduction for 2006. a. $4,925. b. $5,335. c. $6,955. d. $9,850.
Answer: d
26. In May 2006, Shelly purchases computer equipment for $45,000 to use in her business. Assuming that she has net income from her business of $100,000 prior to the deduction, what is the maximum amount of cost recovery Shelly can deduct? a. $ 0. b. $ 6,431. c. $ 9,000. d. $ 45,000.
Answer: d
27. Section 179 expense is available for all of the following business assets except: a. Office building. b. Office furniture.
6-7 c. Computer. d. Delivery truck.
Answer: a
28. Jordan has two jobs. She works as a night auditor at the Moonlight Motel. When her shift at the motel is over, she works as a short order cook at the Greasy Spoon Restaurant. On a typical day, she drives the following number of miles:
Home to Moonlight Motel 4 miles Moonlight Motel to Greasy Spoon Restaurant 7 miles Greasy Spoon Restaurant to home 12 miles
How many miles would qualify as transportation expenses for tax purposes? a. 4. b. 7. c. 11. d. 12.
Answer: b
29. Which of the following is false with respect to the standard mileage rate? a. It can be used if the taxpayer owns the vehicle and uses the standard mileage rate for the first year it was placed in service. b. It includes parking fees, tolls, and property taxes on the vehicle. c. It encompasses depreciation or lease payments, maintenance and repairs, gasoline, oil, insurance, and vehicle registration fees. d. It does not include interest expense on acquisition of the automobile.
Answer: b
30. Frank purchased a vehicle for business and personal use. In 2006, he used the vehicle 70% for business (11,000 miles) and calculated his vehicle expenses using the standard mileage rate. Frank also paid $1,800 in interest and $480 in county property tax on the car. What is the total business deduction related to business use of the car? a. $3,427. b. $4,895. c. $5,023. d. $7,175.
Answer: d
6-8 31. Bryce took a business trip from Boston to Madrid. He was away 14 days of which he spent seven days on business (including 2 travel days) and 7 days vacationing. His expenses are as follows:
Air fare $1,200 Lodging (14 days × $150) 2,100 Meals (14 days × $125) 1,750
Bryce’s travel expense deduction is: a. $2,088. b. $4,175. c. $4,450. d. $5,050.
Answer: a
32. Jake runs a business out of his home. He uses 600 square feet of his home exclusively for the business. His home is 2400 square feet in total. Jake had $27,000 of business revenue and $22,000 of business expenses from his home based business. The following expenses related to his home:
Mortgage Interest $ 10,800 Real Estate Taxes 1,600 Utilities 2,400 Insurance 600 Repairs 2,400 Depreciation (on business use portion of home) 1,200
What is Jake’s Net Income from his business and determine the amount of expenses carried over to the following year, if any? a. ($14,000) and $0 carryover. b. ($650) and $0 carryover. c. $0 and $650 carryover. d. $550 and $0 carryover.
Answer: c – The expenses from the home office can not create a loss in the business.
33. Which of the following is not a relevant factor to be considered in deciding whether an activity is profit-seeking or a hobby? a. Manner in which the taxpayer carries on the activity. b. Expertise of the taxpayer or his or her advisers. c. Time and effort expended by the taxpayer in carrying on the activity. d. Expectations that assets used in the activity could appreciate in value.
Answer: d
6-9 34. Which of the following individuals can deduct the stated educational expenses? a. A real estate broker who attends college to get an accounting degree. b. A CPA who attends a review course to obtain his building contractor’s license. c. A corporate executive attending an executive MBA program. d. An accounting bookkeeper taking a CPA review course to pass the CPA exam and become a CPA
Answer: c
35. Augusta is employed by a local manufacturing firm where she earned $45,000 in 2006. During the year, she also had self-employment income of $20,000. Her self- employment tax is: a. $ 0. b. $ 580. c. $2,826. d. $3,060.
Answer: c
36. The maximum tax bases and percentages for 2006 for the two portions of the self- employment tax are:
Social Security Medicare a. $94,200; 12.4% Unlimited; 2.9%. b. $94,200; 15.3% Unlimited; 15.3%. c. $92,700; 12.4% Unlimited; 2.9%. d. $92,700; 15.3% Unlimited; 15.3%.
Answer: a
Problems
37. Kelly is a self-employed tax attorney whose practice primarily involves tax planning. During the year, she attended a three-day seminar regarding new changes to the tax law. She incurred the following expenses:
Lodging $400 Meals $95 Course registration $350 Transportation $150
a. How much can Kelly deduct? b. Kelly believes that obtaining a CPA license would improve her skills as a tax attorney. She enrolls as a part-time student at a local college to take CPA review
6-10 courses. During the current year, she spends $1,500 for tuition and $300 for books. How much of these expenses can Kelly deduct? Why?
Answer:
Lodging $400.00 Meals (50% deductible) $ 47.50 Registration $350.00 Transportation $150.00 Total Deduction $947.50
Educational expenses are deductible if they are for education that (1) maintains or improves skills by the taxpayer in his employment or (2) meets the express requirement of an employer or law. However, the education expenses are not deductible if the education qualifies the taxpayer for a new trade or business. Since obtaining a CPA qualifies Kelly for a new profession (although related), the expenses are not deductible. In this situation an argument can be made that the education does not qualify Kelly for a new profession because she is already in the tax profession. This argument, however, would be an extremely aggressive position.
38. Jackie owns a temporary employment agency that hires personnel to perform accounting services for clients. During the year, her entertainment expenses for her clients include:
Cab fare to and from restaurants: $ 350 Gratuity at restaurants $ 300 Meals $4,000 Cover charges $ 250
Jackie also held a holiday party for her employees, which cost $1,500. All expenses are reasonable.
a. Can Jackie deduct any of these expenses? If so, how much? ______
b. How is the deduction classified? ______
Answer: (a) Cab Fare 100% deductible $ 350 Gratuity 50% “ “ $ 150 Meals 50% “ “ $2,000 Cover Charges 50% $125
6-11 Party 50% $750.
(b) The cab fare would be travel costs and the others would be considered “meals and entertainment.”
39. David is a college professor who does some consulting work on the side. He uses 25% of his home exclusively for the consulting practice. He is single and 63 years old. His AGI (without consideration of consulting income) is $45,000. Other information follows:
Income from consulting business $4,000 Consulting expenses other than home office $1,500 Total costs relating to home Interest and taxes $6,500 Utilities $1,500 Maintenance and repairs $ 450 Depreciation (business part only) $1,500
Calculate David’s AGI.
Answer: AGI before business $45,000
Business Proceeds $4,000 Business Expenses -$1,500 Interest & Taxes -$1,625* Utilities -$ 375 Main. And Repairs -$ 113 Depreciation limited to $387 -$ 387 Net Business Income 0 AGI $45,000
*75% of this amount would be deductible on Schedule A as an itemized deduction.
40. In 2004, Gerald loaned Main Street Bakery $55,000. In 2005, Gerald he learned that he would probably receive only $6,400 of the loan. In 2006, Gerald received $3,000 in final settlement of the loan. Calculate Gerald’s possible deductions with respect to the loan for 2004, 2005, and 2006.
Answer: If Gerald has a business relationship [see Reg. §1.166-5(b)(2)] with Main Street Bakery, then Gerald is allowed an ordinary deduction of $52,000 in 2006. A non-business bad debt is treated as a short-term capital loss. There
6-12 would be no deduction in 2004 or 2005 because the debt was not worthless and there was some prospect of collection.
41. Charles, a self-employed real estate agent, attended a conference on the impact of the new building codes on real estate investments. His unreimbursed expenses were as follows: Airfare $480 Lodging 290 Meals 100 Tuition and fees 650
How much can Charles deduct on his return?
Answer: Since he is self-employed, the expenses are deducted on Schedule C as follows:
Airfare 100% deductible $480 Lodging 100% deductible $290 Meals 50% deductible $ 50 Tuition Fees $650 $1,470
42. Betsy acquired a new network system on June 5, 2006, (5-year class property) for $75,000. She expects taxable income from the business will always be about $175,000, without regard to the §179 election. Betsy will elect §179 expensing immediately. She also acquired 7 year property in July 2006 for $350,000. Determine Betsy’s total cost recovery deduction with respect to her purchases in 2006.
Answer: The answer to this question will vary if §179 is taken on the 5 year asset. Using §179 on this asset is not incorrect but typically a taxpayer would want to take §179 on the asset with the longer life to maximize the deduction over time.
7 year Property §179 $350,000 $108,000 ($108,000) limit Basis $242,000 Depre. Basis $242,000 x .1429 7 year MACRS $ 34,582
5 year Property
Basis $55,000 x .20 5 years MACRS $ 11,000 Total Cost Recovery $153,582
6-13 43. Janet purchased her personal residence in 1997 for $250,000. In January 2006 she converted it to rental property. The fair market value at the time of conversion was $210,000. a. Determine the amount of cost recovery that can be taken in 2006. b. Determine the amount of cost recovery that could be taken in 2006 if the fair market value of the property was $350,000.
Answer: a. The depreciable basis is the lower of the FMV or basis at the date of conversion. Therefore, the depreciable basis is $210,000 depreciated on a 27 ½ year mid-month method.
$210,000 x .03485 = $7,318.50
b. $250,000 x .03485 = $8,712.50
44. On February 4, 2006, Jackie purchased and placed in service a car she purchased for $21,500. The car was used exclusively for her business purposes. Compute Jackie’s cost recovery deduction in 2006 assuming no §179 expense was taken.
Answer: $21,500 × .20 = $4,300 - 5 year MACRS depreciation. However, the total is limited to $2,960 because of the luxury auto limitations.
45. Rueben acquires a warehouse on September 1, 2006 for $3 million. On March 1, 2010, he sells the warehouse. Determine Rueben’s cost recovery for 2006 and 2010.
Answer: 2006 $3,000,000 x .749% = $22,470 2007 2.564% = $76,920 2008 Same as 2004 2009 Same as 2004 2010 X 2.564 x 2.5/12 = $16,025
46. Michael is the sole proprietor of a small business. In June 2006, his business income is $12,000 before consideration of any §179 deduction. He spends $245,000 on furniture and equipment in 2006. If Michael elects to take the §179 deduction on a conference table that cost $25,000 (included in the $245,000 total), determine the cost recovery for 2006 with respect to the conference table.
6-14 Answer: Remember, §179 cannot create a NOL. Therefore, the §179 expense is limited to $12,000.
$25,000 §179 $12,000 ($12,000) $13,000 14.29% $ 1,858 Total Cost Recovery $13,858
47. On June 10, 2006, Huron purchased equipment (7-year class property) for $75,000. Determine Huron’s cost recovery deduction for computing 2006 taxable income. Assume Huron does not make the §179 election.
Answer: $75,000 x 14.29% = $10,717.50.
48. Brittany purchased a building for $500,000 on January 1, 1998. (Purchase price does not include land). Using the statutory percentage method, calculate the cost recovery for 1998 and 2006 if the real property is: a. Residential real property b. Warehouse
Answer: a. 27.5 years 1998 $500,000 x 3.485% = $17,425 2006 $500,000 x 3.636% = $18,180
b. 39 years 1998 $500,000 x 2.461% = $12,305 2006 $500,000 x 2.564% = $12,820
49. Walt purchased a computer for $5,000. He could use the computer exclusively for his business, or he could allow his family to use the computer 60% of the time and 40% would be for business use. Determine the tax deduction for year of acquisition under both alternatives. What is the tax savings if Walt used the computer exclusively for business? Assume that Walt would not elect §179 expensing and that he is in the 25% tax bracket.
Answer:
Exclusive Business Use 5 year MACRS $5,000 x 20% = $1,000 Deduction
60% Personal 40% Business
6-15 5 year S/L $5,000 x 40% = $2,000 x 1/5 x ½ = $200 Deduction
Tax Savings Difference in Deductions $800 x 25% = $200 Savings
50. In 2004, Jessica bought a new truck for $45,000 to use 80% for her sole proprietorship. Total miles driven include 12,000 in 2004, 14,500 in 2005, and 13,000 in 2006. a. If Jessica uses the standard mileage method, how much may she deduct on her 2006 tax return? b. What is the deduction for 2006 assuming the actual method was used from the beginning? (calculate depreciation only – the truck is not limited by the luxury auto rules.)
Answer: a. 13,000 miles x .80 business use = 10,400 miles x 44.5 cents/mile = $4,628
b. $45,000 x 19.2% (Appendix Table 1 – 3rd year of 5 year MACRS) = $8,640 x 80% = $6,912.
This depreciation is assuming the luxury auto limits do not apply. The limits do not apply to autos greater than 6,000 lbs.
51. Jose purchased a vehicle for business and personal use. In 2006, he used the vehicle 18,000 miles (80%) for business and calculated his vehicle expenses using the standard mileage rate. He paid $1,400 in interest and $150 in property taxes on the car. Calculate the total business deduction related to the car.
Answer: The standard mileage rate is for depreciation, maintenance and repairs, gasoline, oil, insurance, and registration fees. Interest and taxes are deductible in addition to the standard mileage rate.
18,000 miles x 44.5 cents = $8,010 Business Portion Interest $1,400 x .80 = $1,120 Taxes $ 150 x .80 = $120 Total Deduction on Schedule C $9,250
The $30 of taxes (20% personal) is deducted on Schedule A as an itemized deduction (see chapter 5)
6-16 52. Jordan took a business trip from New York to Denver. She spent two days in travel, conducted business for nine days, and visited friends for five days. She incurred the following expenses: Airfare $ 550 Lodging 3,000 Meals 900 Entertainment of clients 750
How much of these expenses can Jordan deduct?
Answer: Since the trip is primarily for business (and not foreign travel), 100% of the travel expenses are deductible.
Airfare 100% deductible $ 550 Lodging 9/14 days x $3,000 $ 1,929 Meals 9/14 days x $900 x 50% $ 289 Entertainment 100% x 750 x 50% $ 375 $ 3,143
53. Derrick owns a farm in eastern North Carolina. A hurricane hit the area and destroyed a farm building, some farm equipment, and damaged a barn.
Item Adjusted FMV FMV Insurance Basis Before After Proceeds Damage Damage Building $85,000 $115,000 $0 $55,000 Equipment $68,000 $49,000 $0 $15,000 Barn $95,000 $145,000 $95,000 $35,000
Due to the extensive damage throughout the area, the president of the United States declared all areas affected by the hurricane as a disaster area. Derrick, who files a joint return with his wife, had $45,000 of taxable income last year. Their taxable income for the current year is $150,000, excluding the loss from the hurricane. Calculate the amount of the loss by Derrick and his wife and the year in which they should deduct the loss (Hint: Chapter 5 provides information concerning nationally declared disaster areas).
Answer: Proceeds Basis/Decrease in FMV Gain/loss Bld. $55,000 ($85,000) = ($30,000) Equip $15,000 ($68,000) = ($53,000) Barn* $35,000 ($50,000) = ($15,000) $( 98,000) Ord. Loss
6-17 *Since the Barn was only partially destroyed, the loss is calculated using the lesser of the decrease in FMV or the basis. The decrease in the FMV was only $50,000. Derrick would report the losses on From 4684 pg. 2 and have a $98,000 ordinary loss. Since the loss was in a declared disaster zone, Derrick has the choice of taking the loss against last years income and getting a refund immediately or waiting until filing his current year tax return. Since Derrick only had $45,000 of AGI, the proper strategy would be to use $45,000 of the loss against last year’s income (get an immediate refund) and use the remaining amount of the loss to the current year tax return.
54. Rebecca is a doctor with an AGI of $125,000 before consideration of income or loss from her dog breeding business. Her home is on 15 acres, 10 of which she uses to house the animals and provide them with ample space to play and exercise. Her records show the following related income and expenses for the current year:
Income from fees and sales $2,500 Expenses: Dog food $4,000 Veterinary bills 3,500 Supplies 1,200 Publications and dues 350 a. How must Rebecca treat the income and expenses of the operation if the dog breeding business is held to be a hobby b. How would your answer differ if the operation were held to be a business?
Answer: a. Hobby
Other income, Form 1040 $2,500 Expenses – (Schedule A – Misc. Deductions) $2,500 0
Expenses are allowed in the following order:
1. Expenses already deductible on Schedule A – mainly mortgage interest and property taxes. 2. Other expenses that do not reduce basis of property (non-depreciation expenses) 3. Expenses that reduce basis (depreciation)
b. A loss of $6,550 would be reported on Schedule C as a business.
6-18 55. Eric, who is single, participates in an activity that is appropriately classified as a hobby. The activity produces the following revenues and expenses:
Revenue $12,000 Property taxes 2,000 Materials and supplies 4,000 Utilities 1,500 Advertising 1,900 Insurance 775 Depreciation 5,000
Without regard to this activity, Eric’s AGI is $55,000. Determine how much income Eric must report, the amount of the expenses he is permitted to deduct, and his AGI.
Answer: Hobbie Revenue $ 12,000 Prop. Taxes ($ 2,000) Supplies ($ 4,000) Utilities ($ 1,500) Adv. ($ 1,900) Insurance ($ 775) Income before Depre. $ 1,825 Depr. (limited to income)($ 1,825) Income from hobby $ 0
Eric’s AGI is $55,000.
56. In 2006, Will has self-employment earnings of $180,000. Compute Will’s self- employment tax liability and the allowable income tax deduction of the self-employment tax paid.
Answer: $180,000 x .9235 = $166,230.00
FICA Limit $94,200 x 12.40% = $ 11,681 Medicare $166,230 x 2.9% = $ 4,821 Self-employment tax $ 16,502 x 50% Deduction FOR AGI $8,251
57. Spencer used the following assets in his Schedule C trade or business in the tax year 2006:
6-19 Asset Date Date Sold Business Cost Purchased Use % Computer 1 03/12/03 100% $3,500
Computer 2 05/05/03 05/15/06 100% $4,500
Printer 08/25/06 100% $3,000
Computer 3 05/25/06 100% $2,300 Equipment 03/20/04 100% $2,300 Auto 05/01/06 80% $18,000 Furniture 1 02/12/04 8/25/06 100% $17,000
Furniture 2 08/15/04 100% $6,000
Office Bldg. 04/01/06 100% $230,000
Spencer is a new client and unfortunately does not have a copy of his prior year tax return. He recalls that all of the assets purchased in prior years used MACRS depreciation (no §179 expense was taken). Spencer does not wish to take a §179 deduction this year because he feels he will be more profitable in the future and would like the depreciation deduction at that time. Calculate the current year depreciation allowance for Spencer’s business. Correctly report the amounts on Form 4562.
Answer:
Asset Date Date Busine Cost Method 2006 Expense Purch Sold ss Use Computer 1 03/12/0 100% $3,500 5yr $403 3 MACRS Computer 2 05/05/0 05/15/0 100% $4,500 5yr $259 3 6 MACRS Printer 08/25/0 100% $3,000 5yr $600 6 MACRS Computer 3 05/25/0 100% $2,300 5yr $460 6 MACRS Equipment 03/20/0 100% $2,300 7yr $442 4 MACRS
6-20 Auto 05/01/0 80% $18,000 5yr **$2,368 6 MACRS Furniture 1 02/12/0 8/25/06 100% $17,000 7yr $1,487 4 MACRS Furniture 2 08/15/0 100% $6,000 7yr $1,049 4 MACRS Office Bld. 04/01/0 100% $230,00 39 SL $4,184 6 0
** The regular depreciation would be $2,880 ($18,000 × .8 × .2). However, the luxury auto limits depreciation to $2,368 ($2,960 x .80 business use).
Tax Return Problem #1
Lori has a home health care business she runs as a sole proprietorship. The following are the results from business operations for the tax year 2006:
Gross Receipt from Clients $145,000 Business mileage 35,200 miles 45,000 miles total during the year 2005 Dodge Caravan Placed in Service 05/01/05 Postage (500) Wages (17,000) Payroll taxes ( 1,275) State license fee ( 125) Supplies (5,300) Professional education registration ( 975) Travel to education course Plane $245 Taxi $40 Lodging $110/night × 2 nights Meals per diem $34 × 2 days Business Assets Date Purchased Cost Computer 1 5/18/06 $4,300 Computer 2 6/01/06 $5,700 Printer 3/01/05 $ 800 Copier 3/02/05 $1,700 Furniture 3/01/05 $5,000 Phone (600) Internet service (450) Rent (7,200)
6-21 Insurance (2,000)
Determine Lori’s self-employment income and prepare Schedule C and Schedule SE. §179 expense is elected on all eligible assets (§179 was not taken on assets purchased last year).
Insert Schedule C Filled in One Page
Insert Schedule SE One Page Filled in
Tax Return Problem #2
During 2006, Cassandra Albright, who is single, works part-time at doctors office and receives a W-2. She also has a consulting practice that had the following income and expenses: Revenue $48,000 Laptop computer purchased 4/23/06 $2,300 Travel 2,500 miles for business 13,000 personal Supplies $ 500 Cell phone charge $ 540
Cassandra (SS# 333-33-3333) resides at: 1400 Medical Street Apt. 3A Lowland, CA 12345
6-22 Cassandra’s W-2 Wages $45,300 Federal withholding $ 4,983 Soc. sec. wages $45,300 Soc. sec. withholding $ 2,809 Medicare withholding $ 657 State withholding $ 2,265
1099-INT Old Bank $ 2,300
1099-DIV Bake Co, Inc. Ordinary dividends $ 3,100 Qualified dividends $ 3,100
Cassandra had the following itemized deductions: State income tax withholding (above) $ 2,265 State income tax paid with the 2005 return $ 350 Real estate tax $ 3,450 Mortgage interest $ 12,300
Prepare Form 1040 for Cassandra for 2006. You will need Form 1040, Schedule A, Schedule B, Schedule C, Form 4562, Schedule C, and Schedule SE.
Form 1040 2 full pages
Schedule A One full page
Schedule B One full page
Schedule C One full page
Schedule SE One full page
Tax Return Problem #3
6-23 During 2006, Jason and Vicki Hurting, who are married with two children, had the following tax information. Jason owns his own landscaping business and Vicki works as an executive assistant at a university.
Jason (SS# 333-44-444) and Vicki (SS# 444-33-3333) resides at: 123 Bate Street Bright, AL 54321
They have two kids under the age of 17: Jason Jr. 555-55-5555 Born 1999 Catlin 666-66-6666 Born 2003
Vicki’s W-2 Wages $ 45,800 Federal withholding $ 6,870 Soc. sec. wages $ 45,800 Soc. sec. withholding $ 2,840 Medicare withholding $ 664 State withholding $ 2,290
1099-G from AL – State tax refund – taxable because $2,500 was deducted on last year’s return $ 897
1099-INT First Bank of Alabama $ 225
1099-DIV IBM, Inc Ordinary dividends $ 125 Qualified dividends $ 125
Jason’s Landscaping Revenue $153,000 Wages 41,600 Payroll tax 3,182 Cell phone charge 425 Assets: Purchased Amount Bus. Use Truck 2/05/06 $28,000 100% Mower1 3/08/06 $12,000 100% Mower2 3/08/06 $ 3,400 100% Equip 6/25/06 $ 1,595 100%
The Hurtings had the following itemized deductions: State income tax withholding (above) $ 2,290 Real estate tax $ 2,100 Personal property tax $ 425 Mortgage interest $ 8,300
6-24 Charitable contributions $ 2,400
Prepare Form 1040 for the Hurtings for 2006. You will need Form 1040, Schedule A, Schedule B, Schedule C, Form 4562, Schedule C, and Schedule SE.
Form 1040 2 full pages
Schedule A One full page
Schedule B One full page
Schedule C One full page
Schedule SE One full page
6-25