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Prentice Halls Federal Taxation 2014 Comprehensive 27th Edition Rupert Solutions Manual Download
Prentice Halls Federal Taxation 2014 Comprehensive 27th Edition Rupert Solutions Manual Download
Chapter I:9
Discussion Questions
I:9-1 It is important to distinguish whether an individual is an employee or an independent
contractor (self-employed) because some expenses are only partially deductible by employees or
not deductible at all. A self-employed individual who incurs a business-related expenditure may
deduct, under Section 162, the expense for determining AGI on Schedule C, Form 1040. In
addition, employers pay certain payroll taxes on behalf of their employees. On the other hand, an
individual's employment-related activities, such as travel and transportation, are deductible from
AGI and are subject to different tax rules and regulations. Individuals may prefer to be classified
as employees because the employee portion of the social security tax rate in 2013 of 7.65% (5.65%
in 2012) is less than the self-employment tax rate of 15.3% (13.3% in 2012). This difference is
mitigated somewhat because self-employed individuals receive an income tax deduction equal to
50% of their self-employment tax. Consideration should also be given to the hospital insurance
portion of the FICA tax, which continues to apply without limit at a 1.45% rate for both employees
and employers and at a 2.90% rate for self-employed individuals. p. I:9-3.
Deductible 2%
Non- Nondeductible
From For Deductible Floor
AGI AGI
I:9-3
I:9-5 Kelly may deduct $750 before applying the 2% nondeductible floor. The deduction is
computed as follows:
I:9-6 a. All expenses except personal clothing (e.g., transportation, meals and lodging) are
deductible from AGI and are subject to the 2% nondeductible floor. The meal costs of $1,000
must be reduced by 50%. Thus, the total deductible amount is $8,500 ($9,000 - $500) (subject to
the 2% nondeductible floor). The expenses are deductible because her assignment is temporary in
nature.
b. Same as a. Latoya could deduct the expenses for the nine-month assignment, as that
employment would be considered temporary under Rev. Rul. 93-86. None of her expenses
incurred in Texas after the nine-month assignment would be deductible. pp. I:9-4 through I:9-7.
I:9-7 The travel expenses related to attending the seminars are not deductible since they are
related to the production of rental income under Sec. 212. The registration fees of $1,000 are
deductible for AGI since they are not travel expenses and are related to the rental activity under
Sec. 212.
pp. I:9-8 and I:9-9.
I:9-8 It is necessary to allocate a portion of the total reimbursement to each expense category
because the various unreimbursed amounts would be subject to various limitations such as the 2%
floor and 50% business meal rule. Reimbursed expenses are fully includible in gross income and
are deductible for AGI subject to the accountable plan rules. Unreimbursed employee business
expenses are deductible as a miscellaneous itemized deduction subject to the 2% floor. Meals and
entertainment expenses must be reduced by 50%. pp. I:9-16 through I:9-18.
I:9-10 The actual expense method may be used in subsequent years. However, MACRS under
the regular method may not be used for computing depreciation (straight-line method is required)
and the basis of the automobile must be reduced by 23 cents in 2013 and 2012, 22 cents in 2011,
23 cents in 2010, and 21 cents per mile in 2008 and 2009. p. I:9-11.
I:9-11 The taxpayer may not switch to the standard mileage rate method. If a taxpayer depreciates
an automobile under MACRS or expenses all or part of the automobile under Sec. 179, a change
to the standard mileage rate method is not permitted.
p. I:9-11.
I:9-12 a. The employee must submit a detailed statement on the tax return of the
reimbursements and expense items. The reimbursements are included in gross income and the
expenses are deductible from AGI as miscellaneous itemized deductions (subject to the 2%
nondeductible floor rule) under a nonaccountable plan.
b. No reporting is required under an accountable plan by the employee.
c. No reporting is required for expenses equal to the reimbursement under the
accountable plan rules. The excess expenses are deductible from AGI as miscellaneous itemized
deductions. A proration of the reimbursement against the various expenses is required.
d. No reporting is required under an accountable plan assuming that the excess amount
is repaid to the employer. pp. I:9-16 through I:9-18.
I:9-13 Distance and time requirements were imposed to differentiate employment-related moves
from non-deductible personal motivated moves. The underlying rationale for the deduction is that
such moves are similar to a business expenditure because the move is often necessary to obtain
employment or is an employment-related job transfer. p. I:9-19.
I:9-14 Yes, qualifying moving expenses are not deductible if they are incurred by an unemployed
or a retired individual. To be deductible, qualifying moving expenses must be incurred by an
employee or a self-employed individual. In addition, the required time period to remain in the new
location is longer for self-employed taxpayers (78 weeks) than for employees (39 weeks). If the
unemployed individual incurred moving expenses to accept a job in the new location, the moving
expenses would be deductible assuming the other requirements are met. p. I:9-19.
I:9-15 a. Len’s moving expenses are deductible for AGI so that it does not matter whether Len
uses the standard deduction. The $2,000 reimbursement would offset the $2,000 of moving
expenses. Thus, no amount would be reported on Len's tax return.
b. The reimbursement for nondeductible moving expenses of $800 ($2,000 - $1,200)
must be included in Len’s gross income. pp. I:9-19 and I:9-20.
I:9-18 a. To be deductible the expenditure must be either (1) "directly related to" the active
conduct of a trade or business or (2) "associated with" the active conduct of a trade or business.
b. If there is some direct business benefit expected to be received, the entertainment
of clients should be classified as "directly related" expenses. Entertainment of potential clients
constitutes "associated with" entertainment. “Associated with” entertainment expenses must be
incurred prior to or after a bona fide business meeting. pp. I:9-13 and I:9-14.
I:9-20 No, they are business fringe benefits under Sec. 132 and are not subject to the 50% limit.
p. I:9-13.
I:9-21 No, the business meal expenditure does not qualify as entertainment expenses. Even
though there is a reasonable expectation of business benefit, no business is discussed prior to,
during, or after the meal. Neither the “directly related” nor the “associated with” tests for
deductibility of entertainment expenses have been met. pp. I:9-14 and I:9-15.
I:9-22 None, the club dues are considered to be a personal, nondeductible expense despite the fact
that the use of the facility is primarily for business. Specific business expenses (e.g., meals with
customers) incurred at the club are deductible subject to the 50% disallowance rule. p. I:9-15.
p. I:9-16.
I:9-25 $400 expense incurred for the CPA review course is nondeductible because these expenses
were incurred to meet minimum standards for entry into the profession. The $4,000 incurred for
law school tuition and books is nondeductible because these expenses qualify the taxpayer for a
new trade or business. $500 [$400 + (0.50 x $200)] of continuing education expenses are
deductible from AGI, subject to the 2% nondeductible floor. The $200 of travel related to meals
is subject to the 50% deduction limit. pp. I:9-21 through I:9-23.
I:9-26 a. Yes, Maggie is entitled to an office-in-home deduction because the office is used
exclusively on a regular basis as the principal place of business for a trade or business, and it is
used as a place for meeting or dealing with patients, clients, or customers in the normal course of
business. Additionally, her office is the most significant place for the conduct of her business
activities.
b. No, Marty must prove that working at home is for the convenience of his employer
and that it is not merely helpful or appropriate to work at home. An employee must also meet the
other requirements described in part a.
I:9-27 Employer contributions to a qualified plan are immediately deductible (subject to specific
limitations upon annual contribution amounts) and such amounts are not taxable to an employee
until the pension payments are received. If an employee contributes to the qualified plan, such
amounts may be made on either a pre-tax or after-tax basis. Currently, most employees contribute
to qualified plans on a pre-tax basis. Thus, when pension payments are received upon retirement,
the amounts received are fully taxable. Under a nonqualified deferred compensation plan (such as
a restricted property plan), the employee is taxed upon the FMV of the property contributed at the
earliest date when the property is no longer subject to risk of forfeiture or when the property is
transferable. The employer receives a corresponding compensation deduction at that time.
Clearly, substantial tax benefits are available in qualified plans over nonqualified plans . However,
qualified plans must meet highly restrictive rules and, in some situations, may not be permitted.
pp. I:9-27 through I:9-32.
I:9-28 In a defined contribution plan, fixed amounts (e.g., 8% of each participant's salary) are
contributed for each participant to a separate account. The retirement benefits for that participant
are based on the value of the participant's account at the time of retirement. Defined benefit plans
establish in advance the value of the retirement benefits and a contribution amount is established
based on actuarial tables to fund this amount (e.g., 40% of an employee's average salary for the
five years prior to retirement). A distinguishing feature of a defined benefit plan is that forfeitures
of nonvested amounts (e.g., due to employee resignations) must be used to reduce the employer
contributions that would otherwise be made under the plan. In a defined contribution plan,
however, the forfeitures may either be reallocated to the other participants in a nondiscriminatory
manner or used to reduce future employer contributions. p. I:9-28.
I:9-30 No, generally employer-provided benefits must be 100% vested after five years of service.
p. I:9-29.
• Defined contribution plan contributions are limited to the smaller of $51,000 (in
2013) or 100% of the employee's compensation.
• Defined benefit plans are restricted to an annual benefit to an employee equal to the
greater of $205,000 (2013) or 100% of the participant's average compensation for the
highest three years.
• An overall maximum annual employer deduction of 25% of compensation paid or
accrued to plan participants is placed upon profit sharing and stock bonus plans.
p. I:9-31.
I:9-33 Nonqualified deferred compensation plans are particularly well-suited for use in executive
compensation arrangements because they are not subject to the same restrictions which are
imposed upon qualified plans such as the nondiscrimination and vesting rules. pp. I:9-31 and I:9-
32.
I:9-34 Yes, he should make the Sec. 83(b) election because he will pay a higher tax when the
restrictions lapse due to the substantial appreciation. If the employee does not make the Sec. 83(b)
election the tax consequences from the stock transfer are deferred for both the employee and the
corporation until the lapse of the nontransferability or forfeiture restrictions.
If the election is made, the employee will be taxed on the fair market value of the stock today and
the corporation will receive a deduction for the same amount immediately. The maximum 20%
capital gain rate may increase the attractiveness of this option because capital gain treatment is
accorded upon the eventual sale of the stock, and the marginal tax rate for high-income taxpayers
is 39.6% when taxable income is in excess of $400,000 for 2013 for single taxpayers. pp. I:9-31
through I:9-33.
• The option price must be equal to or greater than the FMV of the stock on the
option's grant date.
• The option must be granted within 10 years of the date the plan is adopted and the
employee must exercise the option within 10 years from the grant date.
• The option must be exercisable only by the employee and is nontransferable except
in the event of death.
• The employee cannot own more than 10% of the voting power of the employer
corporation's stock immediately prior to the option's grant date.
If an employee meets the requirements of an ISO, no tax consequences occur on the grant date
(except that the excess of the stock’s FMV over the option price is a tax preference item) and
LTCG or loss is recognized when the stock is sold. Under a nonqualified stock option
arrangement, ordinary income is recognized either on the grant date or on the exercise date
(depending upon whether the option has a readily ascertainable FMV). LTCG treatment should
favor the ISO for the employee's tax consequences because of the spread between the maximum
15% capital gain rate and the highest rate on ordinary income (i.e., 35%). However, the employer
is more favorably treated under the nonqualified stock option rules because the employer receives
a tax deduction for the amount of compensation that is recognized by the employee. pp. I:9-34
and I:9-35.
I:9-36 If a nonqualified stock option has a readily ascertainable FMV on the grant date, the
employee recognizes ordinary income on the grant date equal to the difference between FMV and
the option price. The employer receives a compensation deduction on the grant date equal to the
same amount that is recognized by the employee. In such case, no tax consequences occur on the
date the option is exercised and the employee recognizes capital gain or loss upon the sale or
disposition of the stock. If a nonqualified stock option has no readily ascertainable FMV, no tax
consequences occur on the grant date. On the exercise date, the employee recognizes ordinary
income equal to the spread between the FMV and the option price and the employer receives a
corresponding compensation deduction. pp. I:9-35 and I:9-36.
I:9-37 Yes, a self-employed individual who is covered by an employer's qualified pension plan is
eligible to establish an H.R. 10 or an SEP plan relative to his or her self-employment income.
p. I:9-37.
I:9-38 For a defined contribution H.R. 10 plan, a self-employed individual may contribute the
lesser of $51,000 or 25% of earned income for 2013 (before the H.R. 10 plan contribution but after
the deduction for one-half of self-employment taxes paid) from the self-employment activity. The
full-time employees must be covered, as required in the rules for qualified plans. p. I:9-37.
I:9-39 The essential differences between a traditional IRA and a Roth IRA are, first, amounts
contributed to a traditional IRA are tax-deductible whereas amounts contributed to a Roth IRA are
not tax-deductible. However, upon withdrawal of amounts from the IRA at retirement, the
withdrawn amounts are fully taxable from a traditional IRA but not taxable from a Roth IRA.
Second, Roth IRAs are available to many more taxpayers as the AGI limits are much higher for
Roth IRAs than for traditional IRAs. pp. I:9-37 through I:9-41.
I:9-41 If Charley rolls his traditional IRA into a Roth IRA, he must include the rollover in his
gross income and pay income taxes on such amount. The principal benefit of doing the rollover
is that when Charley withdraws amounts from his Roth IRA at retirement, no further taxes will be
due. While a precise analysis should be performed, since Charley’s marginal tax rate at retirement
will be no higher than his present rate and he has the funds outside of his IRA to pay the tax, most
analysts conclude that Charley will be better off to do the rollover and pay the tax now. The
principal economic benefit is that the rollover funds in the Roth IRA are able to grow tax-free and
be ultimately withdrawn tax-free. Thus, in Charley’s case, he should be advised to rollover his
traditional IRA into a Roth IRA. Charley is permitted to rollover amounts from his traditional IRA
to a Roth IRA because there are no AGI restrictions after December 31, 2009. pp. I:9-40 and I:9-
41.
I:9-42 While Sally’s AGI of $75,000 is still too high to deduct contributions to a deductible
traditional IRA (maximum AGI of $69,000 (2013) for single taxpayers who are active participants
in an employer-sponsored plan), she is certainly eligible to contribute up to $5,500 to a Roth IRA
as the Roth IRA AGI limit is $112,000 before the phase-out begins. She also is eligible to
contribute to a nondeductible IRA, but the Roth IRA is much superior to the nondeductible IRA.
pp. I:9-37
through I:9-41.
I:9-43 The Coverdale Education Savings Account (CESA) has several important features,
including: (1) the annual contribution into such plans is $2,000, (2) CESAs may be used for
elementary and secondary education expenses, and (3) a distribution from a CESA may be excluded
even if the Hope credit or lifetime learning credit was claimed in the same year. Of course, the same
expenses cannot be used for both the CESA exclusion and one of the two credits. pp. I:9-41 and I:9-
42.
I:9-44 a. An SEP offers small business owners the opportunity to provide retirement benefits
for its employees that are comparable with qualified pension and profit sharing plans with reduced
administrative compliance costs (i.e., reduced paperwork and need for actuaries and CPA tax
specialists in the pension area to assure that the plan qualification requirements are met).
b. A sole proprietor of a small business may establish an SEP for himself rather than
using an H.R. 10 plan. p. I:9-43.
I:9-46 The tax issues related to the possible relocation include the following:
I:9-47 The primary tax issue is whether the office-in-home qualifies as a deduction under the tax
law. To make this determination, the office must meet several tests. First of all, the office must
be used exclusively and on a regular basis as the principal place of business for a trade or business.
Juan does not meet with patients, so the office must be the principal place of business. Second, the
exclusive use of the office must be for the convenience of the employer. Since Juan is self-
employed, he meets this test. Third, for tax years beginning after December 31, 1998, an office
meets the definition of “principal place of business” if (1) the office is used by the taxpayer for
administrative or management activities of the taxpayer’s trade or business, and (2) there is no
other fixed location of the trade or business where the taxpayer conducts substantial administrative
or management activities of the trade or business. pp. I:9-24 through I:9-26.
I:9-48 The major issues that David must address are as follows:
1. Does the education qualify David for a new trade or business? If so, the education
expense would be nondeductible. However, the courts have generally ruled
favorably on the deductibility of education expenses incurred to obtain an MBA
degree.
2. Is the education directly connected with David's employment or trade or business?
Since David is not employed, the IRS may attempt to assert that the education
expenses are not deductible because the taxpayer does not have a current trade or
business. However, some courts have held that education expenses are deductible
if the education is deemed to be only a temporary cessation of a business activity.
The moving expenses are deductible for AGI, thus Mike's AGI is $116,000 ($120,000 -
$4,000).
$116,000 AGI x 0.02 = $2,320 nondeductible expense floor
$6,000 - $2,320 = $3,680 miscellaneous itemized deductions from AGI
+ 4,000 moving expenses for AGI not subject to any limit
$7,680 total deductible expenses
b. Moving expenses are deducted for AGI whereas the remaining items are deducted
from AGI on Schedule A. pp. I:9-4, I:9-5, I:9-13 and I:9-14, I:9-19 and I:9-20.
Commuting expenses are not deductible. For the local transportation expenses, Monique
can compute her deductible expense under either the actual or standard mileage rate method.
b. Each of these items are classified as a for AGI deduction because she is self-
employed.
I:9-52 a. Since Marilyn is on a temporary assignment of less than one year, her tax home is
still considered to be Cleveland and she is “away from home” while in Atlanta. Thus, all of her
expenses are considered travel expenses and she can deduct the following expenses:
b. Expenses are classified as from AGI and are subject to the 2% of AGI floor.
c. $21,650 is deductible computed as follows:
$120,000 x 0.02 = $2,400 nondeductible floor
$24,050 - $2,400 = $21,650 deductible.
d. The airfare for weekend trips, apartment rent and meals would be personal
nondeductible expenses. A portion of the airfare might qualify as a moving expense under Sec.
217.
e. Only the expenses associated with the first ten months would be deductible if the
position of the IRS is upheld by the courts. The $10,000 of expenses for the last seven months is
not deductible because the move lasts more than one year and is considered indefinite for the
extended period. pp. I:9-4 through I:9-16.
I:9-54 a. Since the reimbursement is less than the expenses, an allocation is required. The
$3,000 reimbursement is prorated to the various expenses based upon the amount reimbursed to
the total expenditures (3,000/5,000 = 60%). The deductible amounts are shown below.
b. The $3,000 of reimbursed expenses is deductible for AGI and the $1,800 of
unreimbursed expenses are from AGI subject to the 2% of AGI nondeductible floor. Since the
reimbursement is pursuant to an accountable plan, the $3,000 of for AGI expenses and the $3,000
reimbursement are netted together and are not reported on Maxine’s return. Because Maxine has
other miscellaneous itemized deductions of $1,000, a total of $1,600 of miscellaneous itemized
deductions are deductible ($2,800 miscellaneous itemized deductions - [0.02 x $60,000 AGI] =
$1,600).
c. If Maxine received a $6,000 reimbursement, the $5,000 of employment-related
expenses is fully deductible for AGI and Maxine must return the $1,000 excess amount to her
employer. Since the reimbursement is pursuant to an accountable plan, the $5,000 of for AGI
expenses and the $5,000 reimbursement is netted together and is not reported on Maxine’s return.
If she does not return the $1,000 excess amount, the $1,000 is includible in her gross income.
pp. I:9-4 through I:9-18.
I:9-56 a. $5,000. The transportation expenses for trips within the metropolitan area are
deductible because Cassady has a regular work location at her employer’s office.
b. From AGI as a miscellaneous itemized deduction.
c. $5,000 for AGI. The transportation expenses from Cassady's home to clients within
the metropolitan area are deductible because her residence is her principal place of business (i.e.,
office in home). pp. I:9-9 and I:9-10.
I:9-57 a. $4,060 of the unreimbursed expenses are deductible from AGI, computed as
follows:
c. Although taxpayers are permitted to change from one method to another, there are
specific requirements that must be met. A change from the mileage method to the
actual method must reduce the basis of the automobile by a mileage rate and the
straight-line method must be used in subsequent years. A change from the actual
method to the mileage method is only permitted if the taxpayer used the straight-
line method of depreciation.
I:9-58
a. $7,392. Under the actual cost method, her deductible expenses before the 2% of AGI
floor are computed as follows:
b. $5,936. Under the standard mileage method, her deductible expenses are computed as
follows:
The business meals are not deductible because bona fide business discussions must be
conducted. The country club dues are not deductible despite the fact that the club was used
exclusively for business. Dues to the chamber of commerce are not subject to the club
disallowance rules.
b. For AGI, since Milt is self-employed.
p. I:9-16.
I:9-61 a. 1. Since the Cooper Company maintains an accountable plan and the
reimbursement is equal to the expenses, Latrisha will not report the reimbursement nor deduct the
expenses. Cooper Company may deduct the amount of $9,450 on its return, computed as follows:
Airfare $5,850
Lodging 1,800
Meals ($1,200 x 50%) 600
Entertainment ($2,400 x 50%) 1,200
Total deductible outlays $9,450
Latrisha will not report the $9,000 reimbursement or the $9,000 of deductions for AGI
(accountable plan). She will report the $1,890 as miscellaneous itemized deductions. Cooper
Company may deduct $7,560 on its return [$4,680 + 1,440 + (960 x 50%) + (1,920 x 50%)].
3. Since the reimbursement is greater than the expenses, Latrisha is required
to return the excess ($14,000 - 11,250 = 2,750) to Cooper Company. In addition, she will not
report the $11,250 reimbursement as gross income or deduct the expenses. If Latrisha does not
return the excess reimbursement (even though she is required to under the plan), she must report
the excess of $2,750 as gross income. Assuming Latrisha reimburses Cooper Company the $2,750,
the company can deduct $11,250.
I:9-62 a. Only direct moving expenses are deductible. Thus, Michael's moving expense
deduction is $4,200 computed as follows:
Direct Moving Expenses
Automobile expenses $ 240
Moving van expenses 3,970
Total deductible expenses $4,210
None of the other expenses qualify as moving expenses under Sec. 217. Specifically, no
deduction for meals en route to Chicago is allowed. The points paid to acquire the new
residence should qualify as interest expense if Michael itemizes his deductions.
I:9-63 a. Not deductible, the education qualifies the taxpayer for a new trade or business
b. Yes, deductible for AGI (except that only $100 of meals [$200 x 0.50] is
deductible)
c. Yes, deductible from AGI (assuming the business executive is an employee)
d. Yes, deductible from AGI
e. Not deductible
I:9-64 Anne has three possibilities of tax savings for the education expenses; (1) deductibility as
a trade or business expense under Reg. Sec. 162-5, (2) tax credit as either an American Opportunity
Tax Credit (AOTC) or lifetime learning credit, or (3) tuition deduction (for AGI). Under (1) above,
her college expenses are not deductible under Reg. Sec. 162-5 as the courses qualify her for a new
trade of business. Her expenses will qualify for either the AOTC or lifetime learning credit (See
Chapter I:14 for a more in-depth discussion of education credits). Finally, under (3), her expenses
will also qualify for the tuition and fees deduction as a deduction for AGI (see Chapter I:2 for
Nancy's home office expenses (other than mortgage interest and real estate taxes) are
limited to $37,300 [$40,000 gross income – ($700 mortgage interest and real estate taxes + $2,000
of expenses directly related to the business)].
Thus, the full amount of $1,200 ($700 + $500) deductible expenses is allowed. In addition,
$1,800 of real estate taxes ($2,000 - $200) and $4,500 ($5,000 - $500) of mortgage interest are
deductible as itemized deductions.
b. Yes, because Nancy’s home office expenses exceed the gross income from the
business, her deductions are limited. Using the ordering rules under Reg. Sec. 1.280A-2, Nancy’s
deductions for the year are computed as follows:
I:9-68 a. The entire $12,000 would be taxable to Pat in 2013 because she made the
pension contributions on a pre-tax (deferred) basis. Most employees make their
pension contributions on a pre-tax basis.
b. Since the pension contributions were made on an after-tax basis and relates to a
qualified retirement plan, the $12,000 pension payments will be taxed under the
simplified method for qualified retirement plan annuities. (For a discussion of the
simplified method, see Chapter I:3.) The taxation of the $12,000 is determined as
follows:
I:9-69 a. The tax consequences from the stock transfer are deferred for both employee
Patrick and Bear Corporation until the lapse of the nontransferability and forfeiture restrictions in
year 2018. Thus, Patrick recognizes no compensation income on the receipt of the stock in 2013
and Bear receives no deduction.
b. Patrick would recognize $1,000 (100 shares x $10) of ordinary income subject to
tax in 2013. Bear Corporation receives a $1,000 deduction in 2013.
c. 1. No effect to Patrick despite the fact that he was previously taxed. Bear must
include $1,000 in gross income because it received tax benefit due to the prior deduction.
2. No tax effect
d. 1. There is no tax effect
2. Patrick reports income of $10,000 and Bear receives a $10,000 deduction (100
shares x $100).
e. 1. $120/share x 100 shares = $12,000 - $1,000 basis = $11,000 LTCG for Patrick.
No effect to Bear.
2. $120/share x 100 shares = $12,000 - $10,000 basis = $2,000 LTCG for Patrick.
No effect to Bear. p. I:9-33.
I:9-70 a. Jamal may deduct $2,200 of the contribution for tax year 2013, as the contribution
was made by the due date for the 2013 income tax return. The $59,000 ceiling is exceeded by
$6,000 so 60% ($6,000/$10,000) of the contribution is not deductible. Jamal could elect to treat
the IRA contribution as made for 2014. Since Jamal’s AGI is only $57,000 in 2014 and the income
for 2014 is less than the 2013 limit, he would be eligible to deduct the full $5,500 in 2014. (2014
limitation almost certainly will not decrease.)
b. The deduction is for AGI.
c. Jamal may then deduct $5,500 because the special income limitations in part (a) do
not apply if taxpayer is not an active participant in a qualified plan.
d. $5,500 would then be deductible since Jamal's AGI does not exceed the $95,000
(2013) married joint return limit. Since Jamal has at least $11,000 of earned income, Jamal is
eligible to put $5,500 into an IRA and his spouse is eligible to put $5,500 into a spousal IRA.
Thus, they can contribute and deduct a total of $11,000 into IRAs during 2013. pp. I:9-38 through
I:9-40.
I:9-72 a. Chatham Mae is eligible to contribute $3,300 into a Roth IRA. She is not eligible to
contribute and deduct amounts to a traditional IRA because her income exceeds $69,000. Since her
AGI exceeds $112,000 (2013), she is limited as to how much she can put into a Roth IRA, as follows:
If Chatham Mae elects to not put any money into a Roth IRA, she can contribute $5,500 to a
nondeductible traditional IRA. Finally, if she contributes $3,300 to a Roth IRA, she also can put
$2,200 into a nondeductible traditional IRA. Taxpayers are allowed to put a combined maximum
of $5,500 into all IRAs.
b. The $15,000 distribution to pay off her car loan is not a qualified distribution
because Chatham Mae is not yet age 59½ and does not meet any of the other requirements.
However, under the special ordering rules for nonqualified distribution, Chatham Mae may first
withdraw $12,000 tax-free, to the extent of her contribution to the Roth IRA. The additional
$3,000 is includible in her gross income and also subject to the 10% withdrawal penalty ($3,000
x 10% = $300). Alternatively, if the $15,000 was used for first-time homebuyer expenses, the first
$10,000 is treated as a qualified distribution and, therefore, not taxable. The remaining $5,000 is
treated as being made from contributions, first and then, nontaxable amounts.
c. Chatham Mae is eligible to rollover her traditional IRA to a Roth IRA. She must
include the entire rollover amount in her gross income in the year of the rollover. pp. I:9-39
through I:9-41.
I:9-73 a. Since Jack and Katie’s AGI exceeds $190,000, the annual $2,000 amount that can
be contributed to the CEA accounts must be reduced as follows:
Thus, the maximum that can be contributed to each of the grandchildren ages 10, 12, 15, and 16 is
($2,000 - $400) = $1,600. No contribution may be made for the 19-year old, as she is over 17
years old.
b. The granddaughter may exclude $4,500 of the $7,000 distribution, as these are
qualified education expenses. However, the excess $2,500 is includible in the granddaughter’s
income in 2013 and she is also subject to a 10% penalty, or $250. pp. I:9-41 and I:9-42.
I:9-75 a. January 1, 2013 - no effect since no tax consequences occur on the grant of an
incentive stock option.
April 1, 2015 - no effect except for a $200 [($100 - $80) x 10 shares] tax preference
item for purposes of the alternative minimum tax.
May 1, 2017 - $400 long term capital gain is recognized by Peggy, computed as
follows:
Sale price $ 1,200 ($120 x 10 shares)
Minus: Basis ( 800) ($80 x 10 shares)
LTCG $ 400
Peggy is entitled to long-term capital gain treatment since both of the requirements for incentive
stock options were met. Bell Corporation does not receive a corresponding compensation
deduction.
b. Since Peggy did not hold the stock the required holding period, she would recognize
$200 ordinary income on the sale date equal to the spread between the option price and the exercise
price [($100 - $80) x 10 shares = $200] ordinary income on May 1, 2015. Bell Corporation is
permitted a $200 deduction for compensation on May 1, 2015 because the option is treated as a
nonqualified stock option. On the sale date Peggy also recognizes a STCG of $300 [$1,300 - ($100
x 10 shares)]. pp. I:9-34 and I:9-35.
I:9-76 a. January 1, 2013 - Penny recognizes ordinary income of $20,000 [($100 - $80) x
1,000] shares on the grant date equal to the difference between FMV and option price. Bender
Corporation receives a compensation deduction of $20,000.
January 1, 2014 - There is no tax effect on the exercise date.
January 1, 2016 - Penny recognizes long-term capital gain of $100,000 computed
as follows:
Selling price ($200 x 1,000 shares) $200,000
Minus: Basis ($100 x 1,000 shares) (100,000)
LTCG recognized by Penny $100,000
Comprehensive Problem
I:9-77 Dan and Cheryl’s taxable income tax liability for 2013 is determined below.
Itemized deductions:
Medical expenses $ 4,870
Minus: 10% of AGI ( 17,480) -0-
** Office-in-home expenses
Direct expenses
Supplies $ 290
Telephone 1,100 1,390
Indirect expenses
Utilities ($3,400 x 10%) 340
Homeowner’s insurance ($600 x 10%) 60
Repairs and maintenance ($800 x 10%) 80
Depreciation (see computation below) 615
Mortgage interest ($15,600 x 10%) 1,560
$4,265
Depreciation: $240,000 x 2.564% x 10% = $615
1. Ajax needs to expand its equity base because of its high debt/equity ratio and needs
for growth.
2. Management philosophy favors employee stock ownership for employees and
executives.
3. Conditions are favorable to offer compensation arrangements involving qualified
and nonqualified plan arrangements because the company's stock is publicly traded.
I:9-82 Contained in the new standards of the AICPA's Statements on Standards for Tax Services
(SSTS) is Statement No. 4, which explains that a CPA can use taxpayers' estimates if it is
impractical to obtain exact data and the estimated amounts are reasonable under the facts and
circumstances known to the CPA. However, certain expenses must be evidenced by proper
documentation. Travel and entertainment expenses must, under Sec. 274(d), be substantiated by
adequate documentation by the taxpayer as prescribed in that section. The CPA cannot use
estimates for these amounts.
The client letter should explain to the taxpayer that a deduction cannot be allowed for the
travel and entertainment expenses incurred unless proper documentation has been made under the
requirements of Sec. 274(d) of the Internal Revenue Code. Documentation should include an
expense book or diary containing the time, place, business purpose, and proof of the amount.
Due to the discrepancies in applying the “sleep or rest” rule, the Supreme Court granted
certiorari in U.S. vs. Correll, 389 U.S. 299 (1967), where the Court ruled unfavorably for the
taxpayer in a situation where a traveling salesman pulled his car over to the side of the road and
slept for several hours during trips. Soon after the Correll decision, the Treasury Department
issued Rev. Rul. 75-168, 1974 C.B. 58, which addressed trips of less than 24 hours. According to
the ruling, travel expenses may be deductible for trips of less than 24 hours if it was reasonable for
the taxpayer to require sleep or rest.
In this case, the result is not absolutely clear. It appears that Charley Long used his
judgment to determine whether he needed sleep or rest. It seems fairly clear that he should be able
to deduct his food and lodging on the nights he stayed in a motel. However, on the nights he slept
in his cab, the Correll case may be unfavorable to Charley’s position.
Joe Windsack is clearly committing an act of tax fraud by claiming fictitious deductions.
You as a CPA have the ethical responsibility to inform Windsack that the excess deductions are
not allowable and must not be claimed on his return. Under the Statement on Standards for Tax
Services #6, you cannot associate yourself with a tax return (by signing the return as tax preparer)
if you know that an error exists on the return. If he objects to this treatment, you must withdraw
from this client engagement and not prepare his return for the taxable year.