Fundamentals of Taxation 2014 7th
Edition by Cruz ISBN 0077862295
9780077862299
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CHAPTER 6 – SOLUTIONS END OF CHAPTER MATERIAL
Discussion Questions
1. Discuss the definition of a trade or business. Why does it matter whether a taxpayer is classified as an employee or as self-employed?
Answer:
A trade or business is any activity that is engaged in for profit continually and regularly. The income from a sole proprietorship is netted with related ordinary and necessary business expenses to determine the effect on AGI. Expenses for employees would be Miscellaneous Itemized Deductions subject to the 2% of AGI limit; expenses for self-employed taxpayers would be for AGI deductions.
Learning Objective: 06-01
Topic: Trade or Business Expenses
Difficulty: 1 Easy
RTRP: Yes
2. Discuss the concepts of ordinary, necessary, and reasonable in relation to trade or business expenses.
Answer:
According to §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, it must be customary or usual in the taxpayer’s particular business. The necessary criterion refers to an expense that is appropriate and helpful but 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.
Learning Objective: 06-02
Topic: Trade or Business Expenses
Difficulty: 1 Easy
RTRP: Yes
3. On what form is depreciation reported, and how does it relate to other forms such as Schedules C, E, F, and Form 2106?
Answer:
Depreciation is reported on Form 4562, and the expenses flow from that form to other schedules such as Schedules C, E, F, and Form 2106 that may be used in the tax return. Depreciation is the expense allowed for the wear or loss of usefulness of a business asset. The understanding of depreciation is an 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.
Learning Objective: 06-03
Topic: Trade or Business Expenses
Difficulty: 1 Easy
RTRP: Yes
4. On what type of property is depreciation allowed?
Answer:
Depreciation is allowed on trade or business property or assets used for the production of income 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).
Learning Objective: 06-03
Topic: Trade or Business Expenses
Difficulty: 1 Easy
RTRP: Yes
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.
Learning Objective: 06-03
Topic: Depreciable Basis
Difficulty: 2 Medium
RTRP: Yes
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.
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 1 Easy
RTRP: Yes
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 tax depreciation calculation. Available conventions include the half-year convention, the mid-quarter convention, and the mid-month convention.
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 1 Easy
RTRP: Yes
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 table depreciation percentage 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:
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 appropriate months for mid-quarter and mid-month conventions.
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium RTRP: Yes
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) and is $500,000 for 2013. The expense election is phased out dollar-for-dollar for purchases in excess of $2,500,000. Unused §179 deductions cannot be carried forward unless the expense is disallowed by the lack of business income.
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
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.
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
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.
Learning Objective: 06-04
Topic: Transportation/Entertainment Business Expenses
Difficulty: 1 Easy
RTRP: Yes
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 versus personal use.
Learning Objective: 06-04
Topic: Transportation/Entertainment Business Expenses
Difficulty: 2 Medium
RTRP: Yes
13. Discuss the limits on meals and entertainment. Are meals 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, meals 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. The only time meals are not limited to 50% is when the three conditions on page 6-26 are met.
Learning Objective: 06-04
Topic: Transportation/Entertainment Business Expenses
Difficulty: 1 Easy
RTRP: Yes
14. Discuss the limits on home office expense deductibility.
Answer:
Home office expenses that would not otherwise be 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.
Learning Objective: 06-05
Topic: Bad Debt/Home Office
Difficulty: 3 Hard
RTRP: Yes
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 or her advisers, 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 of the facts and circumstances are to be taken into account and no one factor is determinative in the hobby determination.
Learning Objective: 06-06
Topic: Hobby Losses/Educational Expenses
Difficulty: 3 Hard
RTRP: Yes
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 2013, only the first $113,700 of wages and self-employment income is subject to the Social Security tax. The Medicare tax is not limited.
Learning Objective: 06-07
Topic: Self-employment Taxes
Difficulty: 3 Hard
RTRP: Yes
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
Learning Objective: 06-01
Topic: Trade or Business Expenses
Difficulty: 1 Easy
RTRP: Yes
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
Learning Objective: 06-01
Topic: Trade or Business Expenses
Difficulty: 1 Easy
RTRP: Yes
19. Atlas, a financial consultant, had the following income and expenses in his business:
How much net income must Altas report from this business?
a. $199,150
b. $202,300
c. $202,950
d. $205,450
Answer: b
Feedback: 235,000-18,000-6,000-6,000-2,700 = $202,300; Penalties and speeding tickets are not deductible.
Learning Objective: 06-01
Topic: Trade or Business Expenses
Difficulty: 2 Medium
RTRP: Yes
20. Mandy, a CPA, flew from Raleigh to Seattle to attend an accounting conference that lasted four days. Then she took three days of vacation to go sightseeing. Mandy’s expenses for the trip are as follows:
Mandy’s travel expense deduction is
a. $1,425
b. $1,575.
c. $1,973
d. $2,235.
Answer: a
Feedback: 625 + (4/7 x 1,015) + (4/7 x 525 x 50%) +70= $1,425
Learning Objective: 06-02
Topic: Transportation/Entertainment Business Expenses
Difficulty: 2 Medium
RTRP: Yes
21. On May 5, 2008, Jill purchased equipment for $40,000 to be used in her business. She did not elect to expense the equipment under Section 179 or bonus depreciation. On
January 1, 2013, she sells the equipment to a scrap metal dealer. What is the cost recovery deduction for 2013?
a. $ 892.
b. $ 1,784.
c. $ 3,568 .
d. No deduction allowed.
Answer: b
Feedback: 40,000 x 8.92% x ½ = $1,784
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
22. On April 15, 2011, 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, 2013, he sells the equipment. What is the cost recovery deduction for 2013?
a. $ 0.
b. $ 875.
c. $1,429.
d. $1,749.
Answer: b
Feedback: 10,000 x 17.49% x ½ = $874.50
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
23. Lawrence purchased an apartment building on February 10, 2013, for $330,000, $30,000 of which was for the land. What is the cost recovery deduction for 2013?
a. $ 0.
b. $ 6,741.
c. $ 9,546.
d. $10,660.
Answer: c
Feedback: 300,000 x 3.182% = $9,546
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
24. Roy purchased an office building on March 30, 2009, for $250,000. $25,000 of which was for the land. On July 30, 2013, he sold the office building. What is the cost recovery deduction for 2013?
a. $0.
b. $3,125.
c. $5,769.
d. $6,410.
Answer: b
Feedback: Fourth year, 6.5 months. (225,000 x 2.564% x 6.5/12) = $3,125
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
25. On June 30, 2013, Ken purchased an apartment building for $500,000. Determine the cost recovery deduction for 2013:
a. $4,925.
b. $5,335.
c. $6,955.
d. $9,850.
Answer: d
Feedback: 500,000 x 1.970% = $9,850
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
26. During the year, Cory purchased a log skidder (7-year property) for $55,000 for his business. Assume that he has income from his business of $30,000, and he and his wife have combined salaries and wages income of $40,000. What is the maximum deduction he can take for his business in relation to the log skidder purchase?
a. $7,860.
b. $30,000.
c. $31,429.
d. $55,000.
Answer: d
Feedback: $55,000. He could take Section 179 up to the limit (500,000 in 2013) against active income. Wages and salary are considered active income so the answer would be $55,000.
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 3 Hard
RTRP: Yes
27. Section 179 expense is available for all of the following business assets except
a. Office building.
b. Office furniture.
c. Computer.
d. Delivery truck.
Answer: a
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 1 Easy
RTRP: Yes
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:
How many miles would qualify as transportation expenses for tax purposes?
a. 4.
b. 7.
c. 11.
d. 12.
Answer: b
Learning Objective: 06-04
Topic: Transportation/Entertainment Business Expenses
Difficulty: 2 Medium
RTRP: Yes
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
Learning Objective: 06-04
Topic: Transportation/Entertainment Business Expenses
Difficulty: 2 Medium
RTRP: Yes
30. Frank purchased a vehicle for business and personal use. In 2013, he used the vehicle 70% for business (11,000 business miles incurred equally throughout the year) 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. $5,610.
b. $6,215.
c. $7,811
d. $8,495.
Answer: c
Feedback: (11,000 miles x 56.5 cents/mile)+ 70% (1,800 + 480)= $7,811
Learning Objective: 06-04
Topic: Transportation/Entertainment Business Expenses
Difficulty: 2 Medium
RTRP: Yes
31. Jimmy took a business trip from Dallas to Brazil. He was there for a total of seven days, of which two were weekend. Over the weekend, he spent his time sightseeing and relaxing. His expenses were as follows:
How much is Jimmy allowed to deduct?
a. $ 3,404.
b. $ 3,496.
c. $ 4,598.
d. $ 4,895.
Answer: c
Feedback: 1,400 + 2,100 + 50% (595) + 800= $4,598
Learning Objective: 06-04
Topic: Transportation/Entertainment Business Expenses
Difficulty: 2 Medium
RTRP: Yes
32. Jake runs a business out of his home. He uses 600 square feet of his home exclusively for the business. His home is 2,400 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 relate to his home:
What is Jake’s net income from his business? What amount of expenses is 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
Feedback: The expenses from the home office cannot create a loss in the business. $5000– 25% ($10,800 + $1,600 + $2,400 + $600 + $2,400) = $550 –$550 depreciation = $0; carryover $650
Learning Objective: 06-05
Topic: Bad Debt/Home Office
Difficulty: 3 Hard
RTRP: Yes
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. All of the above are relevant factors.
Answer: d
Learning Objective: 06-06
Topic: Hobby Losses/Educational Expenses
Difficulty: 3 Hard
RTRP: Yes
34. Which of the following individuals can deduct education 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
Learning Objective: 06-06
Topic: Hobby Losses/Educational Expenses
Difficulty: 3 Hard
RTRP: Yes
35. Annie is self-employed and has $58,000 in income from her business. She also has investments that generated dividends of $3,000 and interest of $2,500. What is Annie’s self-employment tax for the year?
a. $ 8,195.
b. $ 8,619..
c. $ 8,874.
d. $ 8,972.
Answer: a
Feedback: $58,000 x 92.35% x 15.3% = $8,195
Learning Objective: 06-07
Topic: Self-Employment Taxes
Difficulty: 3 Hard
RTRP: Yes
36. The maximum tax bases and percentages for 2013 for the two portions of the selfemployment tax are which of the following?
Social Security
Medicare
a. $113,700; 12.4% Unlimited; 2.9%.
b $113,700; 12.4% Unlimited; 15.3%.
c. $110,100; 12.4% Unlimited; 2.9%.
d. $110,100; 15.3% Unlimited; 15.3%.
Answer: a
Learning Objective: 06-07
Topic: Self-Employment Taxes
Difficulty: 3 Hard
RTRP: Yes
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
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 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:
b. Education expenses are deductible if they are for education that (1) maintains or improves skills required by the taxpayer in his employment or (2) meets the express requirements 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. She may be eligible for the tuition deductions/credits but the expenses are questionable as a deduction from self-employment income.
Learning Objective: 06-01
Topic: Trade or business expenses
Difficulty: 3 Hard
RTRP: Yes
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 the following:
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)
(b) The cab fare would be transportation costs and the others would be considered “meals and entertainment.”
Learning Objective: 06-01
Learning Objective: 06-02
Learning Objective: 06-04
Topic: Transportation/Entertainment Business Expenses
Difficulty: 2 Medium
RTRP: Yes
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:
*75% of this amount would be deductible on Schedule A as an itemized deduction.
Learning Objective: 06-05
Topic: Bad Debt/Home Office
Difficulty: 3 Hard
RTRP: Yes
40. In 2011 Gerald loaned Main Street Bakery $55,000. In 2012, he learned that he would probably receive only $6,400 of the loan. In 2013 Gerald received $3,000 in final settlement of the loan. Calculate Gerald’s possible deductions with respect to the loan for 2011, 2012, and 2013
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 2013. A non-business bad debt is treated as a short-term capital loss. There would be no deduction in 2011 or 2012 because the debt was not worthless and there was some prospect of collection.
Learning Objective: 06-05
Topic: Bad Debt/Home Office
Difficulty: 3 Hard
RTRP: Yes
41. Charles, a self-employed real estate agent, attended a conference on the impact of some new building codes on real estate investments. His unreimbursed expenses were as follows:
How much can Charles deduct on his return?
Answer:
Since he is self-employed, the expenses are deducted on Schedule C as follows:
Learning Objective: 06-01
Learning Objective: 06-02
Topic: Trade or Business Expenses
Difficulty: 2 Medium
RTRP: Yes
42. Betsy acquired a new network system on June 5, 2013 (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 and the 50% bonus. She also acquired 7-year property in July 2013 for $350,000. Determine Betsy’s maximum cost recovery deduction with respect to her purchases in 2013:
Answer: Section 179 can be taken up to $500,000 up to the income limitation. The 50% bonus is allowed as well.
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 3 Hard
RTRP: Yes
43. Janet purchased her personal residence in 2003 for $250,000. In January 2013 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 2013:_________________
b. Determine the amount of cost recovery that could be taken in 2013 if the fair market value of the property were $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 27.5 year mid-month method.
$210,000 x .03485 = $7,318.50
b. $250,000 x .03485 = $8,712.50
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
44. On February 4, 2013, Jackie purchased and placed in service a car she purchased for $21,500. The car was used exclusively for her business. Compute Jackie’s cost recovery deduction in 2013 assuming no §179 expense but the bonus was taken:___________________
Answer:
21,500 x50% $ 10,750
MACRS $10,750 x 20% $ 2,150
Total $ 12,900
However, the total is limited to $11,160 because of the luxury auto limitations.
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
45. Rueben acquires a warehouse on September 1, 2013, for $3 million. On March 1, 2017, he sells the warehouse. Determine Rueben’s cost recovery for 2013 through 2017:
Answer:
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
46. Michael is the sole proprietor of a small business. In June 2013 his business income is $12,000 before consideration of any §179 deduction. He spends $245,000 on furniture and equipment in 2013. If Michael elects to take the §179 deduction and no bonus on a conference table that cost $25,000 (included in the $245,000 total), determine the maximum cost recovery for 2013 with respect to the conference table:
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 basis x 14.29% 7-year MACRS 1,858
Total Cost Recovery
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
$13858
47. On June 10, 2013, Huron purchased equipment (7-year class property) for $75,000. Determine Huron’s cost recovery deduction for computing 2013 taxable income. Assume Huron does not make the §179 election or take the bonus.
Answer:
$75,000 x 14.29% = $10,717.50
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 1 Easy
RTRP: Yes
48. Brittany purchased a building for $500,000 on January 1, 2005. The purchase price does not include land. Calculate the cost recovery for 2005 and 2013 if the real property is:
a. Residential real property.
b. A warehouse
Answer:
a. 27.5 years
2005 $500,000 x 3.485% = $17,425
2013 $500,000 x 3.636% = $18,180
b. 39 years
2005 $500,000 x 2.461% = $12,305
2013 $500,000 x 2.564% = $12,820
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
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 the year of acquisition under both alternatives. What is the overall tax savings between the two alternatives? Assume that Walt would not elect §179 expensing or the bonus, 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
5 year S/L $5,000 x 40% = $2,000 x 20% x ½ = $200 Deduction
Tax Savings Difference in Deductions
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 2 Medium
RTRP: Yes
$800 x 25% = $200 Savings
50. In 2011 Jessica bought a new truck for $45,000 to use 80% for her sole proprietorship. Total miles driven include 12,000 in 2011, 14,500 in 2012, and 13,000 in 2013.
a. If Jessica uses the standard mileage method, how much may she deduct on her 2013 tax return (miles were incurred ratably throughout the year)?
b. What is the deduction for 2013 assuming the actual method was used from the beginning? Calculate depreciation only; the truck is not limited by the luxury auto rules. Also, assume §179 was not elected in the year of purchase.
Answer:
a. 13,000 miles x .80 business use = 10,400 business miles 10,400 miles x 56.5 cents/mile = $5,876
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 vehicles greater than 6,000 lbs.
Learning Objective: 06-04
Topic: Transportation/Entertainment Business Expenses
Difficulty: 2 Medium
RTRP: Yes
51. Jose purchased a vehicle for business and personal use. In 2013 he used the vehicle 18,000 miles (80%) for business and calculated his vehicle expenses using the standard mileage rate (mileage was incurred ratably throughout the year). 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 .565) = $ 10,170
Business Portion Interest $1,400 x .80 = 1,120
Taxes $ 150 x .80 = 120
Total Deduction on Schedule C $ 11,410
The $30 of taxes (20% personal) is deducted on Schedule A as an itemized deduction (see chapter 5)
Learning Objective: 06-04
Topic: Transportation/Entertainment Business Expenses
Difficulty: 2 Medium RTRP: Yes
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:
$ 550
900
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.
11/16 days x $3,000 $ 2,063
11/16 days x $900 x 50% $ 309
100% x 750 x 50% $ 375 $ 3,297
Learning Objective: 06-04
Topic: Transportation/Entertainment Business Expenses
Difficulty: 2 Medium
RTRP: Yes
53. Derrick owns a farm in eastern North Carolina. A hurricane hit the area and destroyed a farm building and some farm equipment and damaged a barn.
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 deductible by Derrick and his wife and the years in which they should deduct
the loss (Hint: Chapter 5 provides information concerning nationally declared disaster areas).
*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 Form 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 year’s income and getting a refund immediately or waiting until filing his current year tax return. Since Derrick only had $45,000 of taxable income, 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 on the current year tax return.
Learning Objective: 06-05
Topic: Bad Debts
Difficulty: 2 Medium
RTRP: Yes
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:
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
Form 1040
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.
Learning Objective: 06-06
Topic: Hobby Losses
Difficulty: 2 Medium
RTRP: Yes
55. Eric, who is single, participates in an activity that is appropriately classified as a hobby. The activity produces the following revenue and expenses:
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:
Eric’s AGI is $ 67,000. The income is included but hobby expenses are deducted as miscellaneous itemized deductions subject to a 2% floor (from AGI) except for property taxes, which can be deducted in full as an itemized deduction.
Learning Objective: 06-06
Topic: Hobby Losses
Difficulty: 2 Medium
RTRP: Yes
56. In 2013 Landon has self-employment earnings of $195,000. Compute Landon’s selfemployment tax liability and the allowable income tax deduction of the self-employment tax paid.
Answer:
$195,000 x .9235 = $180,083
FICA Social security limit $113,700 x 12.40% = $ 14,099
Medicare $180,083 x 2.9% = $ 5,222
Self-employment tax $ 19,321 x 50%
Deduction FOR AGI $ 9,661
Learning Objective: 06-07
Topic: Self-Employment Taxes
Difficulty: 3 Hard
RTRP: Yes
57. (Comprehensive) Casper used the following assets in his Schedule C trade or business in the tax year 2013:
Office bldg. 04/01/13 100% $330,000
Casper 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 or Bonus was taken). Casper does not wish to take a §179 but will take the 50% bonus. Calculate the current year depreciation allowance for Casper’s business. Correctly report the amounts on Form 4562.
Answer:
** The luxury auto limits depreciation to $10,044 ($11,160 year 1 limitation multiplied by the 90% business use).
Learning Objective: 06-03
Topic: Depreciation
Difficulty: 3 Hard
RTRP: Yes
Tax Return Problem #1
Cassi (SSN 412-34-5670) has a home cleaning business she runs as a sole proprietorship. The following are the results from business operations for the tax year 2013: Gross Receipt $203,000
Business mileage: 27,000 miles (miles incurred ratably throughout the year) 35,000 miles total during year 2013 Van (over 6,000 lbs) placed in service 01/01/13, cost 27,000
Determine Cassi’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). No bonus depreciation was elected on the 2012 assets.
Tax Return Problem #2
During 2013, Cassandra Albright, who is single, worked part-time at a doctor’s office and received a W-2. She also had a consulting practice that had the following income and expenses:
Laptop computer purchased 4/23/13 (§179 elected) 2,300
Cassandra (SSN 412-34-5670) resides at 1400 Medical Street, Apt. 3A, Lowland, CA 12345. Her W-2 shows the following:
Cassandra made two federal estimated payments of $7,000 each on June 15 and September 15. Prepare Form 1040 for Cassandra for 2013. You will need a Form 1040, Schedule A, Schedule B, Schedule C, Form 4562, and Schedule SE.
Tax Return Problem #3
During 2013, Jason and Vicki Hurting, who are married with two children, had the following tax information. Jason owns a landscaping business, and Vicki works as an executive assistant at a university.
Jason (SSN 412-34-5670) and Vicki (SSN 412-34-5671) reside at 123 Bate Street, Bright, AL 54321. Both children are under the age of 17:
Jason Jr. (412-34-5672) date of birth 7/20/06
Catlin (412-34-5673) date of birth
Vicki’s W-2 information is as follows:
Other Income:
1099-G Alabama state tax refund is taxable because $2,500 was deducted on last
The following information is for Jason’s landscaping business:
(§179 elected)
The truck was over 6,000 lbs. The Hurtings had the following itemized deductions:
The Hurtings made four federal estimated payments in the amount of $3,000 each on their due dates. Prepare Form 1040 for the Hurtings for 2013. You will need a Form 1040, Schedule A, Schedule C, Form 4562, and Schedule SE.