Solutions Manual for Fundamentals of Taxation for Individuals and Business Entities A Practical Appr

Chapter 1—The Professional Practice of Taxation End-of-Chapter Solutions Discussion Questions 1.

Title: Discussion Question 1 Difficulty: Easy Learning Objective 1: 1.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.1 Solution: The goal of tax planning is to maximize after-tax income. After-tax income is net income after reducing revenue for all expenses including federal income taxes. Tax planning should consider tax factors as well as non-tax factors.

Time On Task: 2 minutes 2.

Title: Discussion Question 2 Difficulty: Easy Learning Objective 1: 1.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.2 Solution: The formula to calculate an individual’s taxable income is as follows: Gross income Less: Deductions for Adjusted Gross Income Adjusted Gross Income Less: Greater of Standard Deduction or Itemized Deductions Less: Qualified Business Income Deduction Taxable income Time On Task: 2 minutes 3.

Title: Discussion Question 3 Difficulty: Easy Learning Objective 1: 1.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.2

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Solution: Form 1040 is used to file an individual’s income tax return information. Form 1040SR can be used by those 65 and older.

Time On Task: 1 minute 4.

Title: Discussion Question 4 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.3 Solution: A lower-income taxpayer needs every after-tax dollar earned to pay bills and does not have much discretionary income. If the income tax rate increases, the lower-income taxpayer may have to work more hours at their current job or take on another job to have the same amount of after-tax income. A wealthier taxpayer may view the increased tax rate adversely but has more flexibility with their discretionary income. The wealthier taxpayer may view their leisure time as more important than working extra hours to earn the same after-tax pay.

Time On Task: 4 minutes

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Title: Discussion Question 5 Difficulty: Easy Learning Objective 1: 1.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.3 Solution: Tax planning is the process of estimating an individual’s tax liability for multiple scenarios and/or multiple years and considering ways to reduce it. The appropriate goal for tax planning is to maximize after-tax income. After-tax income is net income after reducing revenue for all expenses including federal income taxes. Tax compliance is determining the tax effects for transactions that have already occurred, including the preparation of tax returns.

Time On Task: 4 minutes 6.

Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge

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Section Reference 1: 1.3 Solution: An open transaction means that the proposed transaction is not yet completed. A closed transaction means that the relevant events have already happened, and the facts are set. This distinction is important because in an open transaction, the facts and results can be changed to achieve a better outcome. A closed transaction does not allow for this.

Time On Task: 3 minutes 7.

Title: Discussion Question 7 Difficulty: Easy Learning Objective 1: 1.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.3 Solution: The marginal tax rate is the rate that applies to the next additional dollar earned. The average tax rate is total income tax divided by taxable income. The effective tax rate is total income tax divided by total income.

Time On Task: 3 minutes 8.

Title: Discussion Question 8 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: If a taxpayer is in a higher tax bracket in the current year and expects to be in a lower tax bracket next year, he would have tax savings from delaying the receipt of income to next year. If the current year’s tax rate is higher, he would receive more tax benefit from accelerating deductible expenses into the current year rather than waiting until the next year when the marginal tax rate would be less.

Time On Task: 4 minutes 9.

Title: Discussion Question 9 Difficulty: Easy Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Application Section Reference 1: 1.3

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Solution: It would be better to accelerate income into the current year if the taxpayer’s current income tax rate is less than it will be in future years.

Time On Task: 2 minutes 10.

Title: Discussion Question 10 Difficulty: Easy Learning Objective 1: 1.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.3 Solution: Three of the following tax planning opportunities are: • rates vary across different time periods • rates vary across different jurisdictions • rates vary across different types of income, and • rates vary across different types of taxpayers.

Time On Task: 3 minutes 11.

Title: Discussion Question 11 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: Tax rates may vary across different jurisdictions. This will result in more or less after-tax cash flow. The revenue generated may be the same, but the after-tax cash flow could be substantially different.

Time On Task: 3 minutes 12.

Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: It is important to identify the character of the income earned because it is possible that different rates apply across the income types. Also, some character types may limit the amount of

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deduction allowed. Individuals currently pay tax at either 0%, 15%, or 20% on long-term capital gains and qualified dividend income. Interest income earned from a municipal bond is taxexempt. And, for individuals, the maximum deduction per year for net capital losses is $3,000 per year. All these examples demonstrate the importance of the character of the income or loss.

Time On Task: 5 minutes 13.

Title: Discussion Question 13 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: A corporation will pay more tax on a net long-term capital gain than an individual. A corporation is a separate legal entity and pays tax at a flat 21%. An individual pays tax on long-term capital gains at a preferential rate of 0%, 15%, or 20%, depending on their filing status and income level.

Time On Task: 4 minutes 14.

Title: Discussion Question 14 Difficulty: Hard Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: Tax = Rate  Base. Static forecasting assumes that the rate and base are independent of one another. Therefore, the tax base would not be affected by a change in the tax rate. Dynamic forecasting assumes there is a relationship (cause and effect) between the two variables. If the tax rate were to increase, it might not necessarily result in the desired outcome. For example, an increase in the gasoline tax might make a taxpayer reconsider their travel plans and take a vacation closer to home because the cost of gas has increased.

Time On Task: 6 minutes 15.

Title: Discussion Question 15 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Application Section Reference 1: 1.3

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Solution: The time value of money results in a dollar received today being worth more than a dollar received later due to the effect that interest rates have on potential buying capacity. The value of a dollar changes over time because of interest rates. During an inflationary period, a dollar received in the future will not buy as much goods as the same dollar received today. Also, a dollar invested today will generate more interest than the same dollar invested at a later date.

Time On Task: 4 minutes 16.

Title: Discussion Question 16 Difficulty: Medium Learning Objective 1: 1.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.4 Solution: Tax avoidance describes a legal method of reducing taxes. The tax law provides tax planning opportunities, and a taxpayer is not expected to pay more than the amount required by law. Tax evasion means reducing taxes illegally.

Time On Task: 3 minutes 17.

Title: Discussion Question 17 Difficulty: Medium Learning Objective 1: 1.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Application Section Reference 1: 1.4 Solution: All professions have a code of conduct so that the general public knows that the individuals in that profession can be trusted. CPAs who engage in unethical conduct may be disciplined by the AICPA. Time On Task: 3 minutes 18.

Title: Discussion Question 18 Difficulty: Medium Learning Objective 1: 1.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.5 Solution:

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There are two sets of rules because each set serves a particular role and purpose. GAAP ensures that the financial statements are prepared fairly, accurately, and consistently across different business industries. Investors and creditors need to know that they can rely on the financial statements in making a sound investment decision. Congress creates tax laws to raise revenue and to meet other economic, social, and political objectives. For example, if a business has a lawsuit pending against it, a disclosure should be made on the financial statement, so an investor is aware of it before purchasing the company’s stock. On the other hand, Congress will not allow a business to deduct the cost of a legal judgment while it is still pending and unclear as to its outcome.

Time On Task: 4 minutes 19.

Title: Discussion Question 19 Difficulty: Easy Learning Objective 1: 1.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.6 Solution: An example of a social objective being met by a tax law is when an employer provides an employee benefit such as health insurance or a 401(k) plan for the benefit of the employees.

There may be little direct business purpose for an employer to provide these benefits and they are costly, but it is socially desirable to encourage this behavior. By allowing a deduction for these expenses Congress reduces the cost of providing these to the employee. There are numerous correct answers including an employer providing disability insurance, reimbursement for adoption expenses, or reimbursement for education by the employee.

Time On Task: 3 minutes 20.

Title: Discussion Question 20 Difficulty: Easy Learning Objective 1: 1.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.6 Solution: An example of an economic objective being met by a tax law is Section 179 and bonus depreciation. The IRC allows businesses to immediately deduct the cost of purchasing qualified assets that normally would be capitalized and written off over the asset’s useful life. Allowing businesses to take an immediate deduction results in large tax savings for the business and is intended to stimulate the economy. Another example is the preferential tax rate on long-term capital gains and qualified dividend income.

Time On Task: 3 minutes

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21.

Title: Discussion Question 21 Difficulty: Medium Learning Objective 1: 1.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.6 Solution: Horizontal equity provides that taxpayers in similar situations should pay similar amounts of tax.

Significant factors can affect the ability to pay such as marital status, dependents, and health.

Vertical equity provides that taxpayers with a greater ability to pay contribute more in taxes than taxpayers with less ability to pay. Vertical equity focuses on a fair rate structure to calculate the tax liability.

Time On Task: 4 minutes 22.

Title: Discussion Question 22 Difficulty: Easy Learning Objective 1: 1.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.7 Solution: Besides income tax, an individual may have to pay property taxes if they own a home, gift tax if they make a gift above the lifetime threshold, or sales tax on the purchase of goods. Other examples include employment taxes and excise taxes.

Time on Task: 2 minutes 23.

Title: Discussion Question 23 Difficulty: Medium Learning Objective 1: 1.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Application Section Reference 1: 1.7 Solution: Hoffman Inc.’s shareholders bear the incidence of the increase in tax liability because the corporation reduced the dividend paid.

Time On Task: 3 minutes 24.

Title: Discussion Question 24 Difficulty: Easy

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Learning Objective 1: 1.8 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.8 Solution: A career in tax can include working as a public accountant, corporate accountant, federal or state/local government accountant, data analyst, estate planner, investment strategist, or attorney, to name a few.

Time On Task: 3 minutes Multiple Choice Questions 1.

Answer: b Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 1.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.2 Solution: The correct answer is Form 1040.

Form 1040 is used to complete and file an individual tax return.

Time On Task: 1 minute 2.

Answer: c Title: Multiple Choice Question 2 Difficulty: Medium Learning Objective 1: 1.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.2 Solution: The correct answer is a taxpayer can deduct the greater of itemized deductions or the standard deduction.

A taxpayer can deduct the greater of his standard deduction based on filing status or his itemized deductions.

Time On Task: 3 minutes 3.

Answer: a Title: Multiple Choice Question 3

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Difficulty: Easy Learning Objective 1: 1.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.3 Solution: The correct answer is marginal tax rate.

The marginal tax rate is used in tax planning because one must consider the tax liability on the next dollar earned.

Time On Task: 2 minutes 4.

Answer: d Title: Multiple Choice Question 4 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: The correct answer is all are examples of tax planning opportunities.

Jurisdiction, time period, and entity type all provide opportunities for tax planning.

Time On Task: 4 minutes 5.

Answer: c Title: Multiple Choice Question 5 Difficulty: Medium Learning Objective 1: 1.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.4 Solution: The correct answer is Taxpayer C owns a candy store (customers may only pay in cash) and does not report any of the $33,000 income received.

Willful underreporting of income is an example of tax evasion. Losing a tax form, such as a Form 1099, and therefore not reporting income, is not tax evasion.

Time On Task: 3 minutes 6.

Answer: c Title: Multiple Choice Question 6 Difficulty: Easy

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Learning Objective 1: 1.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.6 Solution: The correct answer is to tax only the rich and never the poor.

The goals of tax policy makers include raising revenue, social objectives, economic objectives, equity objectives and political objectives. The tax system is not designed to tax only the rich and never the poor.

Time On Task: 2 minutes 7.

Answer: b Title: Multiple Choice Question 7 Difficulty: Easy Learning Objective 1: 1.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.6 Solution: The correct answer is equity.

The disallowance of entertainment expenses is equitable because of the pleasure element of the business activity. Other taxpayers do not receive a deduction for this type of activity because it is personal, so business owners should not either.

Time on Task: 2 minutes 8.

Answer: a Title: Multiple Choice Question 8 Difficulty: Medium Learning Objective 1: 1.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.7 Solution: The correct answer is implicit tax.

Implicit taxes arise when Congress creates a tax advantage that increases the cost of that asset, but these additional costs (implicit taxes) are not paid directly to the government.

Time On Task: 3 minutes 9.

Answer: b Title: Multiple Choice Question 9

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Difficulty: Easy Learning Objective 1: 1.8 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.8 Solution: The correct answer is Certified Public Accountant.

A CPA designation is the most popular certification for tax accountants. The other certifications are also helpful for accountants.

Time On Task: 1 minute 10.

Answer: d Title: Multiple Choice Question 10 Difficulty: Easy Learning Objective 1: 1.8 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.8 Solution: The correct answer is all of these.

All the choices presented are possible careers in taxation.

Time On Task: 2 minutes Brief Exercises 1.

Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 1.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.1 Solution: Taxable income received Less: Tax cost After tax income Time On Task: 4 minutes

$20,000 ( 4,800) ($20,000  24%) $15,200

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Title: Brief Exercise 2 Difficulty: Easy Learning Objective 1: 1.2 Standard 1: AACSB || Knowledge

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Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.2 Solution: Schedule 1 is used to report additional income items and adjustments to income in calculating AGI. Schedule 2 is used to report additional taxes that might be incurred by the taxpayer.

Schedule 3 is used to report additional credits and payments made by the taxpayer.

Time On Task: 2 minutes 3.

Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: The father will pay tax on the $4,300 of dividend income at a 12% rate, a saving of $989 for the family ($8,000 × (35% − 12%)).

Time On Task: 4 minutes 4.

Title: Brief Exercise 4 Difficulty: Easy Learning Objective 1: 1.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.4 Solution: Tax evasion is a significant issue particularly for income taxes. The government has estimated that $1 out of every $6 (about 16%) that should be paid as federal income taxes is not. This percentage would have resulted in underpayment of taxes of approximately $688 billion in 2021.

Time On Task: 3 minutes 5.

Title: Brief Exercise 5 Difficulty: Easy Learning Objective 1: 1.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.5 Solution:

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The purpose of GAAP is to provide financial statements that are useful for decision making by investors, creditors, employees, and other users of the information. The main purpose of the tax laws, by contrast, is to generate revenue to fund the federal government.

Time On Task: 3 minutes 6.

Title: Brief Exercise 6 Difficulty: Easy Learning Objective 1: 1.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.6 Solution: The five main goals that policymakers attempt to achieve with the income tax system are to raise revenue, promote social objectives, stimulate or decelerate economic growth, increase fairness, and political goals.

Time On Task: 3 minutes 7.

Title: Brief Exercise 7 Difficulty: Medium Learning Objective 1: 1.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.7 Solution: Total employment taxes are $13,464 ($88,000  7.65%  2).

Time On Task: 2 minutes 8.

Title: Brief Exercise 8 Difficulty: Easy Learning Objective 1: 1.8 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 1.8 Solution: Characteristics of a successful tax professional include: • • •

Integrity Problem-solving skills Analytical skills 1-14

• Oral and written communication skills • Listening skills • Research skills • Technology agility • Conflict resolution skills Time On Task: 2 minutes Application Problems 1.

Title: Application Problem 1 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: a. Darius has a tax liability of $17,053 [($100,000 − $47,150)  22% + $5,426] b. Henry and Harriet have a tax liability of $34,106 [($200,000 − $94,300)  22% + $10,852] c. Jenny has a tax liability of $15,359 [($100,000 − $63,100)  22% + $7,241] Time On Task: 6 minutes 2.

Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: a. Taxable income received Less: Tax cost After tax income

$100,000 ( 17,053) [($100,000 − $47,150)  22% + $5,426] $ 82,947

b. Taxable income received $ 75,000 Plus: Tax exempt income received 25,000 Revenue received $100,000 Less: Tax cost on $75,000 ( 11,553) [($75,000 − $47,150)  22% + $5,426] After tax income $ 88,447 Time On Task: 8 minutes

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Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: a. Deductible expense paid Less: Tax savings @ 24% After tax cost

$ 35,000 ( 8,400) $ 26,600

b. Deductible expense paid Plus: Non-deductible expense paid Expenses paid Less: Tax savings on $25,000 @ 24% After tax cost Time On Task: 8 minutes

$ 25,000 10,000 $ 35,000 ( 6,000) $ 29,000

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Title: Application Problem 4 Difficulty: Hard Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: Taxable revenue received $125,000 Less: Deductible expenses paid (22,000) Net taxable income $103,000 Less: Tax cost – Single (17,763) [($103,000 − $100,525)  24% + $17,168.50] After-tax taxable income $ 85,237 Plus: Tax-exempt revenue received 15,000 Less: Non-deductible expenses paid (5,000) After-tax net profit $ 95,237 Time On Task: 8 minutes 5.

Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting

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Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: For MFJ, if taxable income is Over $201,050 but not over $383,900 Taxable income Less: Threshold for 24% bracket Income taxed at 24%

Plus: Tax on $201,050 Tax liability Marginal tax rate Average tax rate Effective tax rate Time On Task: 8 minutes

The tax is: $34,337 plus 24% of the excess over $201,050

$261,500 (201,050) $ 60,450  24% $ 14,508 $ 34,337 $ 48,845 24% 18.68% ($48,845/$261,500) 16.80% ($48,845/$290,700)

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Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution:

Bonus  Marginal tax rate Tax cost

Current year $ 25,000  24% $ 6,000

Next year $ 25,000  32% $ 8,000

Net revenue from bonus

$ 19,000

$ 17,000

Sarah should choose to receive her bonus in the current year because it provides $2,000 more after-tax revenue.

Time On Task: 6 minutes 7.

Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting

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Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: Aroon has two tax rates that are changing from the current year to the next year. The federal marginal tax rate is increasing from 24% to 32%, while his state marginal tax rate is decreasing from 10% to 5%. To make a proper decision, you need to analyze Aroon’s combined federal and state marginal tax rates.

Current year Next year

Federal Rate 24% 32%

State Rate 10% 5%

Total Rate 34% 37%

Aroon should take the bonus this year because his combined marginal tax rate is 3 percentage points (37% − 34%) less in the current year versus next year. His increased tax savings by receiving the bonus in the current year is $2,250 ($75,000  3%).

Time On Task: 8 minutes 8.

Title: Application Problem 8 Difficulty: Hard Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: a. Original transaction: Taxable income Tax cost

Year 0 $200,000 $ 34,106 [($200,000 − $94,300)  22% + $10,852]

Before-tax cash flow Less: Tax cost Net cash flow

$200,000 (34,106) $165,894

Net present value

$165,894

b. Restructured transaction: Taxable income Tax cost

Year 0 $50,000 $ 5,5361

Year 1 $100,000 $ 12,1062

Year 2 $50,000 $ 5,5363

Before-tax cash flow Less: Tax cost Net cash flow Discount factor (@ 4%) Present value

$50,000 ( 5,536) $44,464

$100,000 (12,106) $87,894  0.962 $84,554

$50,000 (5,536) $44,464  0.925 $41,129

$44,464

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Net present value

$170,147

Kurt should try to restructure the transaction because it results in a higher net present value of $170,147. [($50,000 − $23,200)  12% + $2,320] [$100,000 − $94,300)  22% + $10,852] 3 [($50,000 − $23,200)  12% + $2,320] Time On Task: 12 minutes 1 2

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Title: Application Problem 9 Difficulty: Hard Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: As a sole proprietor, Butch would incur tax of $27,843 rounded [($145,000 − $100,525)  24% + $17,168.50). As a corporation, the corporation would incur tax of $30,450 ($145,000  21%).

Factors that should be considered before incorporating include: a. Will the business continue to operate at a profit? b. What will be the administrative costs of becoming a corporation? c. What taxes are imposed at the state and local level? d. What is the effect of double taxation?

Time On Task: 8 minutes 10.

Title: Application Problem 10 Difficulty: Easy Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: a. Progressive tax rate tax liability = $12,106 [($100,000 − $94,300)  22% + $10,852] b. Flat tax rate tax liability = $20,000 ($100,000  20%) Time On Task: 4 minutes 11.

Title: Application Problem 11 Difficulty: Hard Learning Objective 1: 1.3

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Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.3 Solution: Quincy’s take-home pay at 20% is $52,000 [$65,000 – (100% – 20%)  $65,000]. To remain at $52,000 after the tax rate is increased to 25%, Quincy will have to earn $69,333: Desired take-home pay = Pre-tax pay / (100% − 25%) = $52,000/75% = $69,333 Therefore, he will have to earn an additional $4,333 to maintain the same take-home pay.

Time On Task: 8 minutes 12.

Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 1.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.6 Solution: Taxable income Tax computation $325,000 8% of $100,000 5% of $100,000 3% of $125,000 Total tax liability

Tax $8,000 5,000 3,750 $16,750

This state has a regressive tax rate structure because the rate decreases as the base increases.

Time On Task: 5 minutes 13.

Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 1.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.7 Solution: No, Dorice will have to pay a use tax of 0.75% to the state of Indiana. A use tax is levied on the sales price of goods that are owned or consumed within a state but were not purchased within that state.

Time On Task: 3 minutes

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14.

Title: Application Problem 14 Difficulty: Medium Learning Objective 1: 1.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 1.7 Solution: a. Option A generates before-tax income of $6,000 ($100,000  6%). Option B generates before-tax income of $4,800 ($100,000  4.8%). Benny pays explicit tax of $1,440 ($6,000  24%) and $0 implicit tax on Option A. Benny pays no explicit tax and $1,200 of implicit tax on Option B. The implicit tax of $1,200 is the difference between the before-tax return on the taxable investment and the tax-exempt investment. b. Option A results in after-tax tax cash flow of $4,560 ($6,000 − $1,440). Option B results in after-tax cash flow of $4,800. Benny should choose Option B. Time On Task: 6 minutes Tax Planning Problems 1.

Title: Tax Planning Problem 1 Difficulty: Hard Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 1.3 Solution: a.

Year 0 Before-tax cash flow/ taxable income $10,000 Less: Tax cost at 24% (2,400) After-tax cash flow $7,600 Discount factor (@ 5%) Present value $ 7,600 NPV $42,750 b.

Year 0 Before-tax cash flow/taxable income -0Less: Tax cost at 24% After-tax cash flow

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Year 1

Year 2

$20,000 (4,800) $15,200 0.952 $14,470

$30,000 (7,200) $22,800 0.907 $20,680

Year 1

Year 2

-0-

$60,000 (14,400) $45,600

Discount factor (@ 5%) Present value

0.907 $41,359

NPV

$41,359

c.

Before-tax cash flow/ taxable income Less: Tax cost at 24% After-tax cash flow Discount factor (@ 5%) Present value

Year 0 $10,000

Year 1 $20,000

Year 2 $30,000

$10,000

$20,000 0.952 $19,040

(14,400) $15,600 0.907 $14,149

$10,000

NPV

$43,189

d. Option c provides the highest net present value.

Time On Task: 15 minutes 2.

Title: Tax Planning Problem 2 Difficulty: Hard Learning Objective 1: 1.3 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 1.3 Solution: a.

C corporation S corporation Net profit $50,000 $50,000 Less: Tax cost ($50,000  marginal rate*) ( 10,500) ( 12,000) After-tax cash flow $39,500 $38,000 *The marginal rate for the C corporation is 21% and for Rafael is 24%. b. Rafael should consider how the corporation’s payments are taxed, how losses are treated by both entity types, state income taxes, and how the type of the income items generated are taxed.

Time On Task: 10 minutes Communication Problem 1) Title: Communication Problem: Careers in Taxation Difficulty: Easy Learning Objective 1: 1.8 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis

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Section Reference 1: 1.8 Solution: Dear Mom and Dad, College has been great so far and I am learning a lot. As you know, I have chosen accounting as my major, and I would like to focus on the area of taxation. Some qualities that a good tax accountant needs are to be detail-oriented, a good listener and observer, a great problem solver, and an excellent communicator. Most people think accountants just sit behind a desk and crunch numbers, but there is so much more! I would like to sit for the CPA exam and become a certified public accountant.

There are so many career choices within taxation that I am exploring. As a public accountant, I can advocate for my clients. I will be involved in tax compliance, research, planning, and decision-making. As a corporate tax accountant, I will get to work in a team environment with other departments within the company, adding valuable input and contributing to the decisionmaking for the betterment of the company. I can work in corporate tax, sales and use tax, international tax, property tax, or state and local tax, to name just a few. I also learned about other areas that I wasn’t as familiar with such as investment planning, estate planning, valuation work, or working for a government agency such as the IRS or a state or local government. I could even work for the FBI; wouldn’t that be cool! Lastly, I could continue my schooling and become a tax attorney. So many options! I hope all is well at home.

Miss you guys, Time On Task: 10 minutes Ethics and Professional Responsibilities Problem 1) Title: Ethics Problem: Preparing a Tax Return Difficulty: Medium Learning Objective 1: 1.4 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 1.4 Solution: Anyone can prepare a tax return. You may give advice, help someone prepare their return, or prepare the return yourself. Your friend or anyone else that you give advice to should know that you are a student and not well versed yet on the complexities of the tax law. If you prepare your friend’s return, you may not accept compensation. Then, the law considers you a paid preparer and there are more stringent rules for this designation.

A paid preparer must have an IRS-issued preparer tax identification number (PTIN) in order to legally prepare a tax return for compensation. Under Circular 230 §10.3, practice before the IRS is limited to CPAs, attorneys, and enrolled agents and they have unlimited representation rights.

Only in limited situations may a person other than a CPA, attorney, or enrolled agent be allowed to practice before the IRS. Circular 230 §10.35 states that a practitioner must possess the

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necessary competence to engage in practice before the Internal Revenue Service. Competent practice requires the appropriate level of knowledge, skill, thoroughness, and preparation necessary for the matter for which the practitioner is engaged.

You may give advice to your friend or prepare your friend’s tax return, but you should not receive payment. As a student, you do not yet have the knowledge needed to take on the legal responsibility of signing tax returns as a paid preparer.

Time On Task: 10 minutes Research 1) Title: Research Problem: Is the Tax Law Constitutional?

Difficulty: Medium Learning Objective 1: 1.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 1.4 Solution: Peter must report the income earned, file tax returns, and pay tax on any resulting liability, plus penalty and interest. The income was generated from services performed and the sale of material related to his activity. Peter does not consider himself a business, but rather a not-for-profit organization that should not pay tax. In Lloyd v. Commissioner, T.C. Memo. 2020-92 (2020), where the petitioner represented himself, neither the IRS nor the Tax Court was swayed by Lloyd’s similar arguments. According to the court, Lloyd identified his role at Christian Media Network as “pastor, prophet, leader, [and] spokesperson,” and at trial, stated that “‘in effect,’ he is ‘Christian Media.’” However, the court noted that Christian Media Network was never operated under a separate legal entity and that Lloyd himself was not a licensed or ordained minister.

Time On Task: 12 minutes

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Chapter 2—Fundamentals of the Federal Income Tax System End of Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Medium Learning Objective 1: 2.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.1 Solution: It is important to distinguish between a trade or business, investment, or personal activity because the tax results are different for each. Income generated from each may have a different character or tax rate. Also, expenses may be deductible or not depending on which type of activity it is associated with.

Time On Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Medium Learning Objective 1: 2.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.1 Solution: Facts that are important in determining whether rental real estate is a business activity, or an investment activity include number of hours performed each year, record keeping, separation of bank accounts, intent on making a profit, and documentation.

Time On Task: 3 minutes 3) Title: Discussion Question 3 Difficulty: Easy Learning Objective 1: 2.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.2 Solution: Realty is land and any structure that is permanently attached to the land. The most common type of asset that is permanently attached to land is buildings. Individuals often refer to realty as real

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property. Personalty is any asset that is not realty. Taxpayers often refer to personalty as personal property.

Time On Task: 3 minutes 4) Title: Discussion Question 4 Difficulty: Medium Learning Objective 1: 2.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.2 Solution: It is important to identify an asset as ordinary, Section 1231, or capital because each category is treated differently for tax purposes. The character of the asset determines whether the asset is depreciable, whether gain is taxed at ordinary or preferential rates, and whether losses can be deducted.

Time On Task: 3 minutes 5) Title: Discussion Question 5 Difficulty: Easy Learning Objective 1: 2.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.2 Solution: The tax law treats an asset as long-term when the asset has been held for more than one year. It is important because if the taxpayer sells an asset and generates a long-term capital gain, then the individual uses a preferential long-term capital gain rate when calculating liability. It is also important in a trade or business because a long-term asset is characterized as a Section 1231 asset.

Time On Task: 3 minutes 6) Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 2.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.3 Solution: The cost basis represents the initial purchase which can include the purchase price, plus cost associated with the purchase including sales tax, shipping costs, set-up costs, appraisal fees, and 2

title insurance. The tax law defines adjusted basis as cost basis plus capital improvements less accumulated depreciation.

Time On Task: 4 minutes 7) Title: Discussion Question 7 Difficulty: Easy Learning Objective 1: 2.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.4 Solution: Yes, the income will be taxable if its receipt meets three conditions: • The taxpayer’s wealth has increased, • The taxpayer has realized the increase in wealth, and • The law does not provide a specific exclusion for this type of income.

Time On Task: 3 minutes 8) Title: Discussion Question 8 Difficulty: Medium Learning Objective 1: 2.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.5 Solution: For an expense to deductible as a business expense, the expense must be: • incurred in operating a trade or business, and • ordinary, necessary, and reasonable.

Time On Task: 3 minutes 9) Title: Discussion Question 9 Difficulty: Easy Learning Objective 1: 2.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.5 Solution: Medical expenses, home mortgage interest expense, real estate taxes, casualty losses, and charitable contributions are some examples of personal expenses that are deductible.

Time On Task: 3 minutes

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10) Title: Discussion Question 10 Difficulty: Medium Learning Objective 1: 2.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.6 Solution: You must compute a realized gain or loss every time there is a sale or disposition of property.

Realized gain or loss is amount realized less adjusted basis. A recognized gain or loss is one that the taxpayer includes in the computation of taxable income.

Time On Task: 4 minutes 11) Title: Discussion Question 11 Difficulty: Medium Learning Objective 1: 2.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.6 Solution: Conceptually, amount realized represents the value that the owner of the property receives because of the disposition. Computing amount realized is a four-step process: Step 1. Cash received Step 2. Plus: Fair market value of any property and services received Step 3. Plus: Liabilities assumed by the buyer, reduced by debts of buyer assumed by seller Step 4. Less: Selling or disposition expenses Time On Task: 4 minutes 12) Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 2.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.6 Solution: The law defines boot as any property exchanged that is not qualified property, including cash.

Time On Task: 2 minutes 13) Title: Discussion Question 13 4

Difficulty: Hard Learning Objective 1: 2.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.6 Solutions: Two reasons why Congress allows gains to be deferred are: 1. The transaction did not generate any cash for the taxpayer, so if the taxpayer did have to pay taxes, the cash must come from other sources.

2. The taxpayer’s economic situation has not changed significantly because of the transaction, so Congress does not believe it is appropriate to tax gains at that time Time On Task: 4 minutes 14) Title: Discussion Question 14 Difficulty: Medium Learning Objective 1: 2.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.6 Solution: For a tax-deferred transaction, the holding period of property received always includes the holding period of the property transferred. Because the taxpayer is deferring gain or loss that has accrued on the asset transferred, then the holding period of the asset received should include the time period during which the deferred gain or loss accrued.

Time On Task: 4 minutes 15) Title: Discussion Question 15 Difficulty: Hard Learning Objective 1: 2.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.6 Solution: The general definitions and formulas are the same for excluded transactions as for tax-deferred transactions with the following exceptions: Boot. Boot is not a consideration in situations where the taxpayer can exclude gain from income. If the transaction meets the appropriate criteria, all realized gains are excluded up to the limit provided by Congress.

Basis. If the taxpayer acquires new property as part of the transaction, his basis in that property will be its cost. There is no need to adjust the cost because there is no deferred gain or loss.

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Holding period. If the taxpayer acquires new property as part of the transaction, the holding period of the new property will begin the day after the taxpayer acquires it. The holding period of the old property does not affect the holding period of the new property because there is no deferred gain or loss.

Time On Task: 6 minutes Multiple Choice Questions 1) Answer: e Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 2.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.2 Solution: The correct answer is All of these All of the choices are correct because they are land or buildings.

Time On Task: 2 minutes 2) Answer: c Title: Multiple Choice Question 2 Difficulty: Easy Learning Objective 1: 2.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.2 Solution: The correct answer is Accounts receivable Accounts receivable is an ordinary asset that produces ordinary income. The computer, delivery truck, and equipment are all Section 1231 assets if used in a trade or business and held longterm.

Time On Task: 2 minutes 3) Answer: b Title: Multiple Choice Question 3 Difficulty: Easy Learning Objective 1: 2.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge 6

Section Reference 1: 2.2 Solution: The correct answer is II, III Both inventory and assets used in a trade or business but held short term are ordinary assets. A personal residence is a capital asset.

Time On Task: 3 minutes 4) Answer: a Title: Multiple Choice Question 4 Difficulty: Medium Learning Objective 1: 2.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.2 Solution: The correct answer is III A personal lawn mower is a capital asset. Equipment used in a trade or business and held long term is a Section 1231 asset. Land owned by a dealer in real estate is inventory. A copyright owned by an author of a book is an intangible ordinary asset.

Time On Task: 3 minutes 5) Answer: c Title: Multiple Choice Question 5 Difficulty: Medium Learning Objective 1: 2.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.3 Solution: The correct answer is $67,775 Purchase price $65,000 Commissions 1,000 Title fee 125 Survey fee 150 Attorney fee 1,500 Initial basis $67,775 The sidewalk is a land improvement and not part of the initial purchase price.

Time On Task: 4 minutes 6) 7

Answer: a Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 2.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.3 Solution: The correct answer is $496,500 Purchase price Plus: Capital improvements Less: Accumulated depreciation Adjusted basis

$500,000 60,000 ($35,000 + $25,000) 63,500 $496,500

The painting ($500) and fence repair ($800) are not capital improvements.

Time On Task: 5 minutes 7) Answer: b Title: Multiple Choice Question 7 Difficulty: Easy Learning Objective 1: 2.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.5 Solution: The correct answer is Mortgage interest expense Home mortgage interest expense is deductible as an itemized deduction.

Time On Task: 2 minutes 8) Answer: c Title: Multiple Choice Question 8 Difficulty: Hard Learning Objective 1: 2.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.6 Solution: The correct answer is $269,000 The amount realized from selling the property is equal to:

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Cash received Plus: FMV of other property received Plus: Liabilities assumed by the buyer Less: Selling expenses Amount realized

$120,000 100,000 50,000 (1,000) $269,000

The $75 for the fence is a repair and does not impact the amount realized.

Time On Task: 5 minutes 9) Answer: d Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 2.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.6 Solution: The correct answer is $55,000 Fair market value of property received Less: Deferred gain Plus: Deferred loss Basis in property received

$65,000 (10,000) 0 $55,000

Because realized gain is $50,000, $20,000 of boot must have been received. The recognized gain is $40,000 [$50,000 (realized gain) − $10,000 (deferred gain)]. Basis in property received is the same $55,000 using the Alternate Formula 1 computed as follows: Adjusted basis in property transferred Plus: Recognized gain Less: Fair market value Of boot received Less: Debt relief Basis in property received Time On Task: 4 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 2.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting 9

$35,000 40,000 20,000 0 $55,000

Standard 3: Bloom's || Application Section Reference 1: 2.1 Solution: Darnell initially had a personal activity. He is now earning income from the audio production, plans on charging bands for his work, and has the intent of making a profit. Darnell should classify his activity as a business.

Time On Task: 3 minutes 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 2.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.2 Solution: If Tito sells the equipment in December, he would have held the asset for less than 12 months and it would be considered an ordinary asset. If Tito sells the equipment on January 10 of next year, he would have held the asset for more than 12 months and it would be considered a Section 1231 asset.

Time On Task: 4 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 2.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.3 Solution: The initial basis for the new equipment would be $65,400, calculated as follows: Purchase price Sales tax Shipping costs Safety tests Overtime paid Total Time On Task: 5 minutes

$55,000 4,200 3,800 1,500 900 $65,400

4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 2.4 10

Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.4 Solution: Luther must include $600 in his income. This is the value of the services he received.

Time On Task: 3 minutes 5) Title: Brief Exercise 5 Difficulty: Easy Learning Objective 1: 2.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.5 Solution: Mason would not be able to deduct the backhoe expense as it is not reasonable for an owner of a hair salon, nail boutique, or juice bar to have such an expense.

Time On Task: 3 minutes 6) Title: Brief Exercise 6 Difficulty: Hard Learning Objective 1: 2.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.6 Solution: The problem states that this exchange of investment land for farming land qualifies for deferral of gain. Shane’s recognized gain is $5,000, calculated as follows: Amount realized Adjusted basis Realized gain

$56,000 ($51,000 FMV of land received + $5,000 cash) (43,000) (Adjusted basis of land given up) $13,000

Recognized gain = Lesser of 1) Realized gain $13,000, or 2) Boot received (cash) $5,000 Time On Task: 6 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium 11

Learning Objective 1: 2.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.1 Solution: a. Personal b. Personal c. Business d. Business e. Investment f. Business Time On Task: 6 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 2.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.2 Solution: a. Natural resource b. Personalty (intangible asset) c. Realty d. Personalty (intangible asset) e. Personalty (tangible) f. Personalty (tangible) Time On Task: 6 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 2.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 2.2 Solution: a. Ordinary b. Capital c. Section 1231 d. Capital e. Ordinary f. Section 1231 12

Time On Task: 6 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 2.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.3 Solution: a.

Purchase price $180,000 Commissions 2,800 Transfer fee 150 Survey fee 100 Appraisal fee 850 Title insurance 600 Initial basis $184,500 b.

Initial basis Plus: Capital improvements Less: Accumulated depreciation Adjusted basis Time On Task: 8 minutes

$184,500 42,000 ( 37,000) $189,500

5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 2.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.4 Solution: Fantasia must include $400 ($100  4) in her income. This is the value of the services she received.

Time On Task: 3 minutes 6) Title: Application Problem 6 Difficulty: Easy Learning Objective 1: 2.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting 13

Standard 3: Bloom's || Application Section Reference 1: 2.5 Solution: You must tell Raul that these types of charges are not deductible because they are personal expenses. Only expenses related to the business that are ordinary, necessary, and reasonable are deductible. Raul should be advised to have the bookkeeping records corrected and advised of the potential consequences of the errors if they are not corrected.

Time On Task: 3 minutes 7) Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 2.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.6 Solution: Cash received Plus: FMV of other property received Plus: Liabilities assumed by the buyer Less: Selling expenses Amount realized Less: Adjusted basis Realized and recognized gain Time On Task: 8 minutes

$300,000 0 250,000 (31,500) ($30,000 + $1,000 +$500) $518,500 ( 220,000) $298,500

8) Title: Application Problem 8 Difficulty: Hard Learning Objective 1: 2.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.6 Solution: a.

Amount realized $172,000 ($142,000 + $30,000) Less: Adjusted basis (140,000) Realized gain $ 32,000 b.

Recognized gain, $30,000 = Lesser of: Realized gain $32,000, or fair market value of boot received $30,000

c.

Deferred gain ($2,000) = Realized gain ($32,000) less recognized gain ($30,000)

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d.

Adjusted basis in property transferred Plus: Recognized gain Less: Fair market value of boot received Less: Debt relief Basis in property received

$140,000 30,000 ( 30,000) ( 0) $140,000

Alternate Formula 2 is computed as follows: Fair Market value of property received Less: Deferred gain Plus: Deferred loss Basis in property received

$142,000 ( 2,000) 0 $140,000

e.

For a tax-deferred transaction, the holding period of property received always includes the holding period of the property transferred.

Time On Task: 13 minutes 9) Title: Application Problem 9 Difficulty: Hard Learning Objective 1: 2.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.6 Solution: a.

Amount realized $155,000 ($130,000 + $25,000) Less: Adjusted basis (125,000) Realized gain $ 30,000 b.

Recognized gain, $30,000

c.

Deferred gain ($0) = Realized gain ($30,000) less recognized gain ($30,000)

d.

The basis in the land purchased is its purchase price (FMV) of $130,000. The basis in the cash received is $25,000.

e.

For a taxable transaction, the holding period of property received begins on the day after the purchase.

Time On Task: 13 minutes 10) Title: Application Problem 10 Difficulty: Hard 15

Learning Objective 1: 2.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 2.6 Solution: a.

Amount realized $172,000 ($142,000 + $30,000) Adjusted basis (140,000) Realized gain $ 32,000 b.

There is no recognized gain in this scenario, so the recognized gain is $0.

c.

The deferred gain is zero, because Chase excludes the gain and it will not be taxed in the future.

d.

The basis in the property received is the property’s fair market value, $142,000.

The basis in the boot received is $30,000.

e.

If the taxpayer acquires new property as part of the transaction where the gain is excluded, the holding period of the new property will begin the day after the taxpayer acquires it.

Time On Task: 13 minutes Tax Planning Problem 1) Title: Tax Planning Problem 1 Difficulty: Medium Learning Objective 1: 2.5 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 2.5 Solution: You need to determine which expenses are incurred in operating his business. Most likely this is the case for advertising and supplies. Michael may use the computer and car in operating his business, but you will need to determine the business use percentage and personal use percentage. The mortgage interest expense, real estate taxes, and utilities relate to his personal residence. Because he works from home, he can allocate a percentage of these expenses to his business. The percentage will depend on what percentage of his home Michael uses as a qualified home office.

Time On Task: 5 minutes Communication Problem

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1) Title: Communication Problem Difficulty: Medium Learning Objective 1: 2.5 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 2.5 Solution: Hello Jakari, Thank you for giving me the opportunity to explain what is considered a reasonable salary.

Various courts have ruled on the issue prompting the IRS to create IRS Fact Sheet 2008-25 to use the following factors to determine reasonable salary: • Comparable salaries at other companies • Duties and responsibilities • Training and experience • Time and effort devoted to the business • The employee’s compensation as a percentage of net and gross income • Dividend history • Payments to non-shareholder employees • Timing and manner of paying bonuses to key people • Compensation agreements It is important to use due diligence when deciding on a salary because if the IRS deems the salary lacking in value, they can impute salary or reclassify existing payments such as dividends, and payments for healthcare, insurance, utilities, and other such expenses.

If you have any further questions, please do not hesitate to contact me.

Sincerely, Carnes & Youngberg, CPAs Time On Task: 12 minutes Ethics Problem 1) Title: Ethics Problem Difficulty: Medium Learning Objective 1: 2.4 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 2.4 17

Solution: Porter has an increase in wealth that he has realized. There is not an exclusion for this in the tax law so he should report the $1,000 on his tax return. The tax law labels items of this nature as a “treasure trove” and they are taxable. A practitioner has the responsibility to inform his client of what the law holds to be income under IRC §61(a) and reportable. Circular 230 10.22(a) states that a practitioner must exercise due diligence in preparing or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to Internal Revenue Service matters.

Time On Task: 8 minutes Research Problem 1) Title: Research Problem Difficulty: Medium Learning Objective 1: 2.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 2.4 Solution: Individual taxpayers with income or loss from trading in securities may be either traders or investors. Traders are those who engage in the trade or business of buying and selling securities for their own account and spend a considerable amount of time and expense in doing so. A trader is operating a business, and losses from trading are ordinary losses. Investors are those who engage in buying and selling of securities for their own account, but the activity does not rise to the level of a trade or business. Because they are treated as investors, the assets they trade are capital assets and losses from the trading are capital losses.

At first glance, it would appear that Danny is a trader, not an investor. He spends 30 hours a week analyzing, researching, and creating spreadsheets to trade bitcoin. And he executes up to 500 trades per year. But, according to Endicott, T.C. Memo. 2013-199, and Nelson, T.C. Memo.

2013-259, Danny would not meet the high standard that the tax law provides for a trader. In these two tax court decisions, the courts looked at trading frequency, regularity, and the continuous nature of the trading activity. Based on these judicial decisions, Danny is an investor and not a trader. Danny's level of trading activity isn’t enough for him to clear the hurdle to be considered a trader rather than an investor, this is not Danny’s only source of activity and income, and his 500 trades a year are not enough to be a trader. Also, it is not clear if bitcoin is even considered a security. Both the SEC chairman, Jay Clayton, and former CFTC chairman, Gary Gensler, have issued statements stating that bitcoin is not considered a security.

Danny will need to file amended returns to reflect capital losses on his tax returns because net capital loss deductions are limited to $3,000 per year. He may also incur penalties for substantial understatement of income.

Time On Task: 20 minutes CPA Exam Preparation: Task-Based Simulation 18

Difficulty: Medium Learning Objective 1: 2.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 2.6 Solution: A What is the Halls' amount realized on the sale of their principal residence?

What is the Halls' adjusted basis on the sale of their principal residence?

What is the realized gain on the sale?

B $273,400 $213,650 $59,750

Rationale: Amount realized = Sales price $277,000 Less: Settlement charges (3,600) (from settlement statement) Amount realized $273,400 Property taxes are an itemized deduction, and they cannot use them in computing amount realized.

Adjusted basis = Purchase Price $182,000 Plus: Settlement charges 4,150 (from settlement statement) Plus: Capital improvements 27,500 ($25,000 + $2,500) Adjusted basis $213,650 Property taxes are an itemized deduction, so they do not impact adjusted basis. Capital improvements made to a residence increase the basis of the home. Repair and maintenance items are not considered capital improvements.

Realized gain = Amount realized Less: Adjusted basis Realized gain

$273,400 (213,650) $ 59,750

Time On Task: 12 minutes

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Chapter 3—Tax Authority, Compliance Rules, and Professional Responsibilities End of Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Easy Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: Primary sources of authority consist of legislative, including the Constitution and the Internal Revenue Code, administrative, and judicial sources. Secondary sources of authority provide commentary on the primary authority and include IRS publications, legal journals and opinions, treatises, and tax articles.

Time On Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Medium Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: The legislative process for a tax bill begins in the House Ways and Means Committee. It will then move on to the full House of Representatives. Once approved by the House, the tax bill will move on to the Senate Finance Committee for revisions, additions, and deletions. After approval in the Senate Finance Committee, the full Senate will vote on its approval. If the original House bill and the Senate bill are substantially different, both versions are considered by the Joint Conference Committee. The bill from the Joint Conference Committee must then be approved by the House and Senate. The final version is sent to the president for approval or veto. If the president vetoes a bill, Congress can override the veto with a two-thirds vote in each chamber.

Time On Task: 4 minutes 3) Title: Discussion Question 3 Difficulty: Easy Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge

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Section Reference 1: 3.1 Solution: 280A is the section number, (c) is the subsection, (1) is the paragraph, and (A) is the subparagraph.

Time On Task: 2 minutes 4) Title: Discussion Question 1 Difficulty: Easy Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: Administrative sources of tax law include Treasury Department Regulations, Revenue Rulings, Revenue Procedures, and Private Letter Rulings, as well as various other administrative pronouncements.

Time On Task: 3 minutes 5) Title: Discussion Question 5 Difficulty: Medium Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: Regulations help explain and interpret the tax law. A proposed regulation provides guidance on a new law or changes to an existing regulation. Taxpayers and other parties provide comments on the proposed regulation before Treasury finalizes it. A final regulation carries the full force and effect of law. A temporary regulation is issued when a tax law area needs immediate attention and guidance on a substantive matter of the law. A temporary regulation carries the full weight value as a final regulation and may be cited as precedent. Temporary regulations expire after three years from the date of issuance.

Time On Task: 4 minutes 6) Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1

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Solution: Revenue Rulings are public administrative rulings by the Internal Revenue Service (IRS) that apply the law to factual situations. A Revenue Ruling can be relied on as precedent by all taxpayers. A Private Letter Ruling (PLR) is issued to one specific taxpayer who has requested guidance on a tax matter. Only that taxpayer may rely on the PLR and it is in response to a request regarding an open or proposed transaction by the taxpayer.

Time On Task: 4 minutes 7) Title: Discussion Question 7 Difficulty: Easy Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: The three courts of original jurisdiction (trial courts) are the U.S. District Court, the U.S. Court of Federal Claims, and the U.S. Tax Court.

Time On Task: 3 minutes 8) Title: Discussion Question 8 Difficulty: Medium Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: Acquiescence indicates that the IRS will follow the decision in future situations involving similar facts and issues. Nonacquiescence indicates that the IRS will not follow the decision and can be expected to litigate in situations involving similar facts and issues.

Time On Task: 4 minutes 9) Title: Discussion Question 9 Difficulty: Easy Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution:

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The Small Case Division of the Tax Court hears tax cases involving $50,000 or less. No appeal is available, and the case cannot be used as a precedent. The case is informal, and the taxpayer does not need an attorney.

Time On Task: 2 minutes 10) Title: Discussion Question 10 Difficulty: Medium Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: The Supreme Court might agree to hear a tax case when there are conflicting opinions at the Circuit Court of Appeals level regarding tax cases with similar facts and circumstances presented.

Time on Task: 2 minutes 11) Title: Discussion Question 11 Difficulty: Easy Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: If a tax treaty and the Internal Revenue Code are in direct conflict, the taxpayer will rely on the most recent law enacted.

Time On Task: 2 minutes 12) Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: One must consider the following when assessing the validity of sources of tax law: a. Whether the source is primary or secondary authority b. If a regulation, is it a Final, Temporary, or Proposed regulation c. The residency state of the taxpayer d. The level of the court

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Time On Task: 4 minutes 13) Title: Discussion Question 13 Difficulty: Medium Learning Objective 1: 3.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.2 Solution: The Tax Research Process has 7 steps: 1. Identify: All relevant facts 2. State clearly: The problem to be solved 3. Locate: The applicable tax authority 4. Evaluate: The relevance and weight of the authorities 5. Identify: Possible solutions 6. Identify: The recommended solution 7. Communicate: Your results to your client Time On Task: 4 minutes 14) Title: Discussion Question 14 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.3 Solution: The statute of limitations sets the period during which one party can pursue a cause of action against another party. The statute of limitations regarding tax assessment runs for three years from the later of (1) the due date of the return, or (2) the date the return was filed.

Time On Task: 3 minutes 15) Title: Discussion Question 15 Difficulty: Hard Learning Objective 1: 3.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.3 Solution: The failure to file a tax return penalty is imposed on the tax balance due at 5% per month (up to 25%) with a minimum penalty amount of the lesser of $510 (2024) or the amount of tax due. If

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there is no balance due with the tax return, there is no failure to file penalty imposed. The minimum penalty applies only if the taxpayer does not file the tax return within 60 days of the due date and the computed penalty amount is less than the minimum penalty.

The failure to pay the tax due penalty is imposed on the tax balance due at 0.5% per month (up to 25%). If there is no balance due with the tax return, there is no failure to pay penalty imposed. A fraction of a month counts as a full month for both penalties. If both the failure to pay penalty and the failure to file penalty potentially apply, the maximum penalty for both is limited to 5% of the tax due per month.

Time On Task: 8 minutes 16) Title: Discussion Question 16 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.3 Solution: Examples of an accuracy related penalty include errors from negligence, substantial understatement of a taxpayer’s tax liability, as well as substantial or gross misvaluation. The most serious civil accuracy penalty the IRS can assess a taxpayer is for fraud.

Time On Task: 4 minutes 17) Title: Discussion Question 17 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.3 Solution: Examples of tax return preparer penalties include but are not limited to: • Penalty for understatement due to taking an unreasonable position on a tax return.

• Penalty for willful and reckless conduct.

• Penalty for improper use of tax return data.

• Penalty for failure to sign a tax return.

• Penalty for not providing a copy of the tax return to the taxpayer.

Time On Task: 4 minutes 18) Title: Discussion Question 18 Difficulty: Medium

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Learning Objective 1: 3.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.3 Solution: Substantial authority is based upon weighing the supporting evidence and authority for taking a position on the tax return. Substantial authority indicates a probability that the taxpayer’s position will be sustained upon audit or litigation and is generally held to be 40% or less. The “more likely than not” standard is defined as a greater than 50% chance of a position being sustained on its merits.

Time On Task: 4 minutes 19) Title: Discussion Question 19 Difficulty: Medium Learning Objective 1: 3.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.4 Solution: Circular 230 includes regulations governing practice before the Internal Revenue Service and is issued by the Treasury Department.

Time On Task: 2 minutes 20) Title: Discussion Question 20 Difficulty: Medium Learning Objective 1: 3.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.5 Solution: IRS audits include correspondence examinations, office examinations, and field examinations. A correspondence examination is conducted by mail and usually limited to one or two items. An office examination is conducted by the IRS Revenue Agent conducts the audit at the IRS local office. They are typically broader in scope and complexity than a correspondence examination. A field examination is conducted at the taxpayer’s place of business. Field examinations are the broadest in scope, are more complex, and can last months to years.

Time On Task: 5 minutes Multiple Choice Questions 1)

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Answer: c Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: The correct answer is Tax Court decision.

A Tax Court decision is a primary source of authority. The Journal of Taxation, Wiley tax text, and an IRS publication are all secondary sources.

Time On Task: 2 minutes 2) Answer: d Title: Multiple Choice Question 2 Difficulty: Easy Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: The correct answer is Wiley tax textbook.

The Wiley tax textbook is a secondary source of authority. A Revenue Ruling, a Supreme Court decision, and an Internal Revenue Code section are all primary authority.

Time On Task: 2 minutes 3) Answer: a Title: Multiple Choice Question 3 Difficulty: Easy Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: The correct answer is The Wall Street Journal.

The Wall Street Journal is not a primary source of authority. Legislative, Administrative, and Judicial are all primary sources of authority.

Time On Task: 2 minutes 4) Answer: c

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Title: Multiple Choice Question 4 Difficulty: Easy Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: The correct answer is Both are equal and depends on which is more recent.

Both an Internal Revenue Code section and a treaty are primary authority but carry equal weight.

Whichever law was most recently written should be followed.

Time On Task: 2 minutes 5) Answer: c Title: Multiple Choice Question 5 Difficulty: Easy Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: The correct answer is Paragraph.

The subpart (3) is the paragraph subpart.

Time On Task: 2 minutes 6) Answer: d Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: The correct answer is Golsen Rule.

The Golsen Rule states that the Tax Court will follow previous decisions in the Circuit Court of Appeals that will have jurisdiction on appeal.

Time On Task: 2 minutes 7) Answer: c Title: Multiple Choice Question 7 Difficulty: Easy

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Learning Objective 1: 3.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.3 Solution: The correct answer is April 15.

Form 1040 is due on April 15 unless April 15 falls on a Saturday, Sunday or holiday. Then, the next business day that is not a holiday will be used.

Time On Task: 3 minutes 8) Answer: d Title: Multiple Choice Question 8 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.3 Solution: The correct answer is April 15, Year 7.

If Barb filed her tax return on February 14, Year 4, the statute of limitations for assessing additional liability is three years from the later of (1) the due date the tax return, or (2) the date the tax return was filed.

Time On Task: 3 minutes 9) Answer: b Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.3 Solution: The correct answer is $150.

The penalty for failure to file is 5% of the tax due per month (or partial month). The maximum penalty is 25%. Heather’s penalty is $150 ($1,500  5%  2 months).

Time On Task: 4 minutes 10) Answer: b Title: Multiple Choice Question 10 Difficulty: Easy

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Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.3 Solution: The correct answer is $60.

The tax practitioner is obligated to sign the tax return. The penalty for failure to sign is $60 per return up to a maximum penalty of $31,500 (2024).

Time On Task: 2 minutes 11) Answer: d Title: Multiple Choice Question 11 Difficulty: Medium Learning Objective 1: 3.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.4 Solution: The correct answer is All of these.

CPAs, Enrolled Agents, Attorneys, and Enrolled Actuaries may practice before the IRS as well as Enrolled Retirement Plan Agents for limited situations.

Time On Task: 4 minutes 12) Answer: d Title: Multiple Choice Question 12 Difficulty: Medium Learning Objective 1: 3.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.4 Solution: The correct answer is Rick must promptly tell Luka of the error and Rick should consider not preparing Luka's tax returns in the future if Luka refuses to bring the error to the IRS's attention.

A CPA must promptly inform the client of the error and should consider resigning from the engagement if the client refuses to bring the error to the IRS’s attention. The key fact is that the error caused the client to substantially underpay her taxes.

Time On Task: 5 minutes 13) Answer: c Title: Multiple Choice Question 13

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Difficulty: Medium Learning Objective 1: 3.1, 5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1, 5 Solution: The correct answer is 90-day letter.

The Statutory Notice of Deficiency is referred to as the 90-day letter because the taxpayer has 90 days from the date of the notice to file a petition to the U.S. Tax Court or pay their deficiency.

Time On Task: 3 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: The District Court requires the taxpayer to pay the deficiency first before going to court, allows a jury trial, has multiple judges but only one judge hears the case, and has 94 courts throughout the United States.

The Tax Court does not require payment before going to court, does not allow a jury trial, has 19 regular judges, and specializes in tax authority.

The U.S. Court of Federal Claims requires the taxpayer to pay their deficiency first before going to court, does not allow a jury trial, has 16 judges, and meets only in Washington D.C. Time On Task: 6 minutes 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 3.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.2 Solution: Treasury Regulations (legislative), Treasury Regulations (interpretive), Treasury Regulations (procedural), Revenue Rulings, Revenue Procedures, and Private Letter Rulings.

Time On Task: 5 minutes

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3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.3 Solution: Individuals aged 65 and older can use Form 1040-SR, and married couples may if at least one spouse is at least 65 years old. Form 1040-SR makes it easier for taxpayers to report retirement distributions and social security payments. Form 1040-SR has larger font than Form 1040 making it easier to read.

Time On Task: 3 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 3.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.4 Solution: Circular 230 lists numerous acts of incompetence or disreputable conduct that are sanctionable, including: • Being convicted of any crime under federal tax laws.

• Being convicted of any crime involving dishonesty or breach of trust.

• Being convicted of any state or federal felony that renders the practitioner unfit to practice before the IRS. • Giving false or misleading information to tax officials.

• Willfully evading taxes.

• Being disbarred or suspended from practice as a CPA or an attorney.

• Displaying contemptuous conduct before the IRS. Time On Task: 3 minutes 5) Title: Brief Exercise 5 Difficulty: Medium Learning Objective 1: 3.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.5 Solution:

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If the IRS issues a no change report after an audit, it generally cannot reopen the examination unless fraud or other similar misrepresentation is involved. It is advantageous for the taxpayer because that tax year is typically considered closed and not open for further reexamination.

Time On Task: 5 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: a. Primary b. Primary c. Primary d. Primary e. Secondary f. Neither g. Primary Time On Task: 7 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 3.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: a. Legislative b. Administrative c. Judicial d. Administrative e. Legislative f. Judicial Time On Task: 6 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 3.1

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Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.1 Solution: a. Illinois – 7th b. Alabama – 11th c. California – 9th d. Massachusetts – 1st e. Washington D.C. – District of Columbia circuit f. Hawaii – 9th Time On Task: 6 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 3.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 3.2 Solution: Ranking, beginning with highest weight: a. Internal Revenue code section d. Tax Court decision e. Temporary Regulation b. Letter Ruling c. Article in the Journal of Taxation Time On Task: 5 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.3 Solution: a. The statute of limitations for his 2024 return will expire on April 15, 2028. The primary statute of limitations runs for three years from the later of the due date of the tax return or the date the return is filed. b. If he filed his tax return on October 15, 2025, the statute of limitations will expire on October 15, 2028. The primary statute of limitations runs for three years from the later of the due date of the tax return or the date the return is filed.

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c. If Cain never filed his tax return, then the statute of limitations never begins running.

So, the 2024 tax year will always be an open year that the IRS can audit.

Time On Task: 6 minutes 6) Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.3 Solution: a. Grant’s failure to file penalty is $640 ($6,400  5%  2 months). b. Grant’s failure to file penalty is $1,600 ($6,400  5%  8 months, limited to 25%).

Time On Task: 6 minutes 7) Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.3 Solution: a. Grant’s failure to pay penalty is $64 ($6,400  0.5%  2 months). b. Grant’s failure to pay penalty is $256 ($6,400  0.5%  8 months).

Time On Task: 6 minutes 8) Title: Application Problem 8 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.3 Solution: a. Grant’s failure to file penalty is $1,920 ($6,400  15%  2 months). b. Grant’s failure to file penalty is $4,800 ($6,400  15%  8 months, limited to 75%).

Time On Task: 6 minutes 9) Title: Application Problem 9 Difficulty: Medium

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Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.3 Solution: a. No, Asher would not be subject to penalty because he paid in ($60,000) at least 110% (Income is greater than $150,000) of last year’s tax liability $55,000 ($50,000  110%). b. Yes, Asher is subject to underpayment of estimated tax penalty: Payment 1: The payment due April 15 is for the income earned in January, February, and March. He should have paid in at least $14,000 of taxes for the April 15 payment ($56,000  3 months/12 months). The estimated tax payment was $10,000, so his underpayment is $4,000. The penalty for payment 1 is $160 as shown below.

Payment 2: The payment due June 17 is for the income earned in April and May. He should have paid in at least $9,333 of taxes for the June 17 payment ($56,000  2 months/12 months). The estimated tax payment was $10,000, so his overpayment was $667. There is no underpayment penalty for this quarter.

Payment 3: The payment due September 16 is for the income earned in June, July, and August. He should have paid in at least $14,000 of taxes for the September 16 payment ($56,000  3 months/12 months). The estimated tax payment was $10,000, so his underpayment is $3,333 ($4,000 − $667 overpayment from Payment 2). The penalty for payment 3 is $78 as shown below.

Payment 4: The payment due January 15 is for the income earned in September, October, November and December. He should have paid in at least $18,667 of taxes for the January 15 payment ($56,000  4 months/12 months). The estimated tax payment was $10,000, so his underpayment is $8,667. The penalty for payment 4 is $87 as shown below.

Asher’s total underpayment during the year was $16,000 and his penalty for underpayment of estimated tax is $325.

(A) (B) Underpayment Interest Payment Amount Rate 1 $ 4,000 4% 2 0 4% 3 3,333 4% 4 8,667 4% Total $16,000 Time On Task: 12 minutes

Date Due 4/15/2024 6/17/2024 9/16/2024 1/15/2025

(C) Date Months Paid Late 4/15/2025 12 4/15/2025 10 4/15/2025 7 4/15/2025 3

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(A) × (B) × (C) 12

Penalty $160 0 78 87 $325

Title: Application Problem 10 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.3 Solution: Carole and Luiz will owe $432. They will pay interest of $154 ($18,500  4%  76/365). Their failure to pay penalty will be 1.5% (0.5%  3 months), resulting in a penalty of $278 ($18,500  1.5%).

Time On Task: 5 minutes 11) Title: Application Problem 11 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.3 Solution: Kyle is subject to the 20% accuracy penalty for negligently underreporting his income. The penalty is 20% of the tax due, so his penalty is $10,000 ($50,000  20%).

Time On Task: 5 minutes 12) Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.3 Solution: Norma’s valuation of the property was misstated by 222% [($725,000 − $225,000)/$225,000].

She is subject to the substantial misvaluation penalty of 20% and her penalty is $20,750 ($103,750  20%).

Time On Task: 6 minutes 13) Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting

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Standard 3: Bloom's || Application Section Reference 1: 3.3 Solution: Dale will owe a tax preparer penalty of $1,000. A penalty for the greater of $1,000 or 50% of the income derived by the preparer ($1,750  50% = $875) for preparing the return will be assessed as a penalty for an unreasonable position.

Time On Task: 6 minutes 14) Title: Application Problem 14 Difficulty: Medium Learning Objective 1: 3.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.4 Solution: SSTS #1.1: Advising on Tax Positions sets forth the standard when recommending a position on a tax return. A member should determine and comply with the standards, if any, that are imposed by the applicable taxing authority with respect to advising on tax positions. Under SSTS #1.1.5a, “a member should not advise a taxpayer to take a tax position unless the member has a goodfaith belief that the position has at least a realistic possibility of being sustained administratively or judicially on its merits, if challenged.” Under SSTS #1.1.2, when recommending a tax position or when preparing or signing a tax return on which a position is taken, a member should, “advise a taxpayer of relevant tax disclosure responsibilities and potential penalties.”

Time On Task: 6 minutes 15) Title: Application Problem 15 Difficulty: Medium Learning Objective 1: 3.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.4 Solution: Under SSTS #1.2.6, "a member should promptly inform a taxpayer upon becoming aware of the taxpayer’s failure to file a required return, or an error in a previously filed return."

Under SSTS #1.2.7, “If a member prepares a tax return for the current year or a prior tax year, and the taxpayer has not taken appropriate action to correct an error related to a tax return position in a tax return for a prior year, the member should consider whether to withdraw from preparing the current return and whether to continue a professional or employment relationship with the taxpayer. If the member does prepare the current-year return, the member should take reasonable steps to ensure that the error is not repeated.”

Time On Task: 8 minutes

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16) Title: Application Problem 16 Difficulty: Medium Learning Objective 1: 3.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.4 Solution: CPA Buck will not violate SSTS #2.4.2 if he uses estimates, and he does not disclose that he has used estimates. Unless prohibited by statute, administrative rule, or judicial holdings, a member may use estimates, whether from the taxpayer or other sources authorized by the taxpayer [...] if it not practical to obtain exact data and if the member determines that the estimates are reasonable based on the facts and circumstances known to the member. He will violate SSTS #2.4.2 if he uses estimates provided by Melba that appear on their face to be materially inaccurate. Buck cannot also indicate the expenses using cents instead of dollars. This would indicate the expenses were precise down to the penny which they are not.

Time On Task: 6 minutes 17) Title: Application Problem 17 Difficulty: Medium Learning Objective 1: 3.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 3.5 Solution: If CPA Sanjay and Dee disagree with the Revenue Agent Report (RAR) and receive the 30-day letter, Dee may pay the deficiency or have Sanjay write a written protest requesting an Appeals Conference. If Dee does not respond to the 30-day letter or does not reach agreement in the appeals process, a 90-day letter is issued. The 90-day letter is significant in that this is the time that the taxpayer has to file a petition with the Tax Court. If the taxpayer does not file the petition in a timely manner, the taxpayer's only judicial recourse is through the U.S. District Court or the U.S. Court of Federal Claims, both of which require the deficiency to be paid before the judicial process can begin.

Time On Task: 6 minutes 18) Title: Application Problem 18 Difficulty: Medium Learning Objective 1: 3.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application

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Section Reference 1: 3.5 Solution: As the tax accountant, you should advise Holly on how the tax return was prepared and how the tax liability is calculated. At age 17, Holly can sign her own tax return, but her mom is allowed to do so as well.

Time On Task: 6 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Medium Learning Objective 1: 3.1 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 3.1 Solution: If Butch files in Tax Court, he does not have to pay his deficiency before going to court. He will not be allowed a jury trial in Tax Court. If you think Butch’s case is detailed and would benefit from having a tax expert rule on the case, he should choose the Tax Court because their judges hear only tax cases and are well versed in tax law. Decisions of the Tax Court are appealed to U.S. Court of Appeals. As a matter of policy known as the Golsen Rule, the Tax Court will follow the law of the circuit to which a case is appealable.

If Butch files in District Court, he will have to pay his deficiency before he can go to court. He will be allowed a jury trial. Judges are not tax specialists, because all types of legal matters are tried in district court. If you choose district court for your tax dispute, you must file with the district court based on your permanent residence.

Time On Task: 8 minutes 2) Title: Tax Planning Problem 2 Difficulty: Medium Learning Objective 1: 3.4 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 3.4 Solution: The CPA may disclose the client’s tax information to the CPA’s attorney for the evaluation and defense against the negligence claim. The CPA and his attorney have attorney/client privilege and the CPA can disclose the information to help in his defense.

Time On Task: 4 minutes 3)

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Title: Tax Planning Problem 3 Difficulty: Medium Learning Objective 1: 3.5 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 3.5 Solution: Shan should have you review all open tax returns for accuracy and to make sure that any tax liability has been paid. Shan agreed to have Bob sign the returns on her behalf. This creates joint and several liability for each spouse, which means that the IRS can collect the entire tax liability from either spouse. Therefore, Shan has exposure for previous tax return filings and tax liability for tax years that are still open.

Time On Task: 6 minutes Communication Problem 1) Title: Communication Problem: Preparer Responsibility Difficulty: Medium Learning Objective 1: 3.2 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 3.2 Solution: Memo to Client Hello Sly and Suzy, I have visited your bar and restaurant several times and have always enjoyed the experience. I will definitely recommend it to friends and family. I know that you would like to deduct all your meals and entertainment expenses because they relate to your business, but the Internal Revenue Code (IRC) is very clear that there are limitations on their deductibility.

In order for an expense to be deductible, it must be ordinary, necessary and reasonable as it relates to the business. I believe that your meals and entertainment expenses fit this criterion.

However, the IRC states that 50% of business meals are deductible in 2024 and none of the business entertainment expenses are deductible. The government does not want to subsidize the pleasure element of these activities, and therefore curbs the entertainment deduction.

I am sorry that I did not have better news for you. I hope to see you soon at your restaurant!

Sincerely, Carnes & Youngberg, CPAs

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Tax memo to the file Facts: Sly and Suzy own a bar and restaurant in town that specializes in serving local breweries’ beverages. They frequently visit their vendors and pay for the meals and entertainment. For the current year, their QuickBooks account reflects $8,000 in entertainment expenses and $12,000 for meals. Sly and Suzy would like to deduct all of these expenses because they are all business related.

Issue: Can Sly and Suzy deduct all their business meals and entertainment expenses?

Conclusion: No, they may deduct 50% of their business meals and 0% of the entertainment expenses.

Analysis: §162(a) of the Internal Revenue Code defines business expenses as the ordinary and necessary expenses of carrying on a trade or business. Generally, business expenses are tax deductible. It would be expected that a bar and restaurant owner would incur business meals and entertainment expenses in the ordinary course of running their business. §274(a)(1)(A) generally disallows a deduction for any item with respect to an activity of a type considered to constitute entertainment, amusement, or recreation (entertainment expenditures). §274(n)(1) generally limits the deduction of food or beverage expenditures to 50 percent of the amount that otherwise would have been allowable. They must not be lavish or extravagant. Substantiation is needed for the food and beverages expense under §162.

Time On Task: 20 minutes Ethics Problem 1) Title: Ethics Problem: Relying on Third Party Information Difficulty: Medium Learning Objective 1: 3.4 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 3.4 Solution: The penalty for an unreasonable position is the greater of $1,000 or 50% of the preparer’s payment with respect to the return. Sheila could be assessed $1,125 ($2,250  50%). Sheila can avoid the penalty by showing reasonable cause for why she claimed the deduction and that she acted in good faith. If the IRS agent determines that Sheila showed willful and reckless conduct, the penalty will equal the greater of $5,000 or 75% of her payment with respect to the return.

Sheila would be assessed $5,000 in that case.

Time On Task: 10 minutes Research Problem

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1) Title: Research Problem: Timely Filing of Tax Return Difficulty: Medium Learning Objective 1: 3.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 3.3 Solution: The taxpayer is assessed a penalty if he or she fails to file a return, files it late, and/or fails to pay the tax due. These penalties do not apply if the taxpayer can prove a reasonable cause for the error. One question concerning reasonable cause is whether the taxpayer meets the reasonablecause requirement if he or she relied on the adviser to file the return or accepted the adviser's incorrect filing date?

The Supreme Court considered this question in Boyle (469 U.S. at 246) and the District Court decided this exact issue in Intress vs US. (404 F.Supp.3d 1174 (2019). In Boyle, the taxpayer relied on the tax advisor to file an estate tax return and the return was accidentally filed late. In Intress, the same fact pattern as the Collins was presented and the court found the penalty applied. The Supreme Court in Boyle ruled against the taxpayer, stating that the return due date is a fixed date. Therefore, it is a bright line, and a taxpayer cannot reasonably fail to file on time by relying on an adviser to handle the paperwork. In Intress, the taxpayer argued that the Boyle case cannot be considered because e-filing did not exist at that time. In today’s environment, the taxpayer relies on a CPA to e-file the extension and return because the CPA has the proper software. The district court, however, found that Boyle applied to Intress because, like the taxpayer in Boyle, they were not required to use tax preparation services.

Based on these decisions, it is reasonable to assume that the taxpayer will not be able to prove reasonable cause based on reliance on a tax adviser if the return was not filed on time or the liability was not paid. The IRS will penalize the taxpayer in these situations. Therefore, the Collins will not have reasonable cause and will not be able to recoup the penalty.

Time On Task: 25 minutes

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Chapter 4—Dependents and Filing Status End of Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Medium Learning Objective 1: 4.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.1 Solution: It is still important to understand the dependency rules to properly apply other provisions of the tax law such as filing status, earned income credit, and the child tax credit. Also, it is important to understand the law as it applied before 2018 if your client is being audited for a year before 2018.

Time On Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Easy Learning Objective 1: 4.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.1 Solution: For the relationship test, a qualifying child includes children, grandchildren, great-grandchildren and other descendants, brothers and sisters, nieces and nephews and their descendants (grandnieces/grandnephews), stepchildren, adopted children, and foster children, and stepsiblings, half-siblings, and descendants of these relatives.

Time On Task: 2 minutes 3) Title: Discussion Question 3 Difficulty: Medium Learning Objective 1: 4.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.1 Solution: If both individuals are parents, they do not file a joint return, and all the other dependency tests are met, then the parent with whom the child resided the longest during the tax year claims the 1

exemption. The custodial parent can waive the dependency claim to the other party by signing Form 8332. If this child resides with both parents for an equal period of time during the tax year, the parent with the higher AGI can claim the parent. Also, if a parent is eligible to claim the qualifying child, the parent can allow another eligible individual to claim the child if the eligible individual (for example, a grandparent) has a higher AGI for the tax year than the AGI of the parent or of any other person eligible to claim the child.

Time On Task: 2 minutes 4) Title: Discussion Question 4 Difficulty: Easy Learning Objective 1: 4.1, 2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.1, 2 Solution: Differences between the qualifying child test and the qualifying relative test can include: •

The qualifying child test includes the residence test—The dependent must have the same principal place of abode as the taxpayer for more than half of the tax year.

• The qualifying child test includes the age test—The dependent must be under the age of 19 at the end of the taxable year, or under the age of 24 if a full-time student for at least 5 months of the tax year.

• The qualifying child must not be self-supporting—To be claimed as a dependent, the individual must not have provided more than 50% of his or her own support.

• The qualifying relative test includes a support test—The taxpayer must provide more than 50% of the dependent’s total support.

• The qualifying relative test includes the gross income test—The dependent’s gross income must be less than the exemption amount for the year ($5,050 for 2024). Gross income is defined as only income that is taxable.

Time On Task: 4 minutes 5) Title: Discussion Question 5 Difficulty: Medium Learning Objective 1: 4.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.2 Solution: Antonio, Sofia, and Julio each provide more than 10% and together provide greater than 50% their mom’s support. If they agree to a multiple support agreement (Form 2120), they can designate who claims their mom as a dependent each year, as long as the other dependency requirements are met. They can rotate this benefit each year.

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Time On Task: 3 minutes 6) Title: Discussion Question 6 Difficulty: Easy Learning Objective 1: 4.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.3 Solution: Filing status is determined on the last day of the taxable year.

Time On Task: 1 minute 7) Title: Discussion Question 7 Difficulty: Medium Learning Objective 1: 4.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.3 Solution: A spouse may need to file a separate return because: •

The taxpayer has concerns that the information reported by their spouse on a MFJ return is not true or accurate. Individuals sign tax returns under penalty of perjury, and it is a felony to sign a tax return that one knows is not correct. Therefore, the spouse files MFS to avoid signing a return that may have false information on it.

• The taxpayer does not know the location of his or her spouse so a MFJ return cannot be signed. Or the spouse refused to sign a MFJ return, leaving no option but to file MFS. • The spouses can pay less tax as MFS than if they file MFJ. This is rarely the case because the tax laws for MFS have more restrictions and limitations than MFJ. • Non-tax reasons for filing MFS would include prenuptial agreements or estate planning.

Time On Task: 4 minutes 8) Title: Discussion Question 8 Difficulty: Hard Learning Objective 1: 4.2, 4.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.2, 4 Solution:

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If a qualifying relative is a parent, the parent need not live with the taxpayer for head of household status to be available, but the taxpayer must provide more than 50% of the cost of maintaining the parent’s home. Novak can file as head of household.

Time On Task: 4 minutes 9) Title: Discussion Question 9 Difficulty: Medium Learning Objective 1: 4.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.4 Solution: An abandoned spouse is a married taxpayer who is allowed to file as though they are unmarried.

An abandoned spouse may file as head of household if the following requirements are met: a) The taxpayer’s spouse has not lived in the home for the last six months of the calendar year, and b) The taxpayer provides more than half of the cost of maintaining a home for themself and a dependent child.

Time On Task: 3 minutes 10) Title: Discussion Question 10 Difficulty: Medium Learning Objective 1: 4.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.5 Solution: Yes, Dylan can deduct a standard deduction even if his parents claim him as a dependent. A limited standard deduction is allowed. The limited standard deduction is the greater of $1,300 (2024) or earned income plus $450 (2024) limited to the regular standard deduction.

Time On Task: 3 minutes 11) Title: Discussion Question 11 Difficulty: Easy Learning Objective 1: 4.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.5 Solution: 4

The kiddie tax applies to all children who are under the age of 18 and have unearned income greater than $2,600 (for 2024). It also includes children who: a) are under age 18, or b) their earned income does not exceed 50% of their total support for the year and: 1. Are age 18, or 2. Over the age of 18 but under age 24 and are full-time students.

Time On Task: 2 minutes 12) Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 4.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.5 Solution: Zeke’s total income is $3,700 ($3,200 + $500). His limited standard deduction equals his earned income of $3,200 + $450, or $3,650, because that exceeds $1,300. Therefore, his taxable income is $50 ($3,700 − $3,650). All of Zeke’s income will be taxed to Zeke at his tax rate of 10% (2024). Zeke is age 16, but his unearned income is less than $2,600 (2024) so none of his unearned income will be taxed at his parent’s tax rate.

Time On Task: 4 minutes 13) Title: Discussion Question 13 Difficulty: Medium Learning Objective 1: 4.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.6 Solution: Many taxpayers who are not required to file a tax return should do so anyway. For example, if they have had federal income tax withheld from their wages, the only way they can receive a refund of the withheld taxes is to file a tax return.

Time On Task: 2 minutes Multiple Choice Questions 1) Answer: a Title: Multiple Choice Question 1

Difficulty: Easy Learning Objective 1: 4.1 5

Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.1 Solution: The correct answer is $0.

For tax years 2018-2025, the deduction for personal and dependency exemptions is suspended.

Time On Task: 1 minute 2) Answer: d Title: Multiple Choice Question 2 Difficulty: Easy Learning Objective 1: 4.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.1 Solution: The correct answer is All of these.

The relationship, age, and not self-supporting tests as well as the residence, joint return, and citizenship test must be met to claim a qualifying child.

Time On Task: 2 minutes 3) Answer: d Title: Multiple Choice Question 3 Difficulty: Easy Learning Objective 1: 4.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.1 Solution: The correct answer is Gross income test.

The gross income test is not required for a qualifying child. The gross income test is a requirement to determine a qualifying relative.

Time On Task: 2 minutes 4) Answer: c Title: Multiple Choice Question 4 Difficulty: Easy Learning Objective 1: 4.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting 6

Standard 3: Bloom's || Knowledge Section Reference 1: 4.1 Solution: The correct answer is University scholarships for academic excellence.

Almost all revenue is included if funds are used for support, except for scholarships.

Time On Task: 2 minutes 5) Answer: d Title: Multiple Choice Question 5 Difficulty: Hard Learning Objective 1: 4.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.1 Solution: The correct answer is All of these.

The custodial parent claims the child as a dependent unless waived.

Time On Task: 5 minutes 6) Answer: d Title: Multiple Choice Question 5 Difficulty: Medium Learning Objective 1: 4.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.2 Solution: The correct answer is Two. Cindy is under the age of 24, a full-time student, and does not provide greater than 50% of her own support. She is considered a qualifying child. Jeremy is 33 so he does not qualify as a qualifying child, but he meets the gross income test for a qualifying relative because he earned only $2,000 for the year which is less than the exemption amount of $5,050 (2024). His parents provide more than 50% of his support so Jeremy is a qualifying relative.

Time On Task: 4 minutes 7) Answer: a Title: Multiple Choice Question 7 Difficulty: Easy Learning Objective 1: 4.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting 7

Standard 3: Bloom's || Knowledge Section Reference 1: 4.3 Solution: The correct answer is Single.

Everyone who is unmarried and does not qualify for qualifying widow(er) or head of household status must file as single.

Time On Task: 1 minute 8) Answer: d Title: Multiple Choice Question 8 Difficulty: Medium Learning Objective 1: 4.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.3 Solution: The correct answer is Single.

If a couple is legally separated with a separate maintenance agreement at the end of the year, they must each file as single.

Time On Task: 3 minutes 9) Answer: d Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 4.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.4 Solution: The correct answer is Assuming Sharon lives alone after her husband's death in Year 10, she must file as single for Year 10.

Married filing joint is automatic in the year of death.

Time On Task: 5 minutes 10) Answer: c Title: Multiple Choice Question 10 Difficulty: Easy Learning Objective 1: 4.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge 8

Section Reference 1: 4.4 Solution: The correct answer is Divorced.

Divorced is not an available option. Single, qualifying widow(er), and head of household are all acceptable filing statuses.

Time On Task: 1 minute 11) Answer: c Title: Multiple Choice Question 11 Difficulty: Medium Learning Objective 1: 4.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.4 Solution: The correct answer is Food consumed in the home—Yes; Value of services rendered in the home by the taxpayer—No. For head of household filing status, the following costs are considered in determining whether the taxpayer has contributed more than one-half the cost of maintaining the household: rent, mortgage interest, taxes, insurance on the home, repairs, utilities, and food eaten in the home.

The following costs may not be considered: clothing, education, medical treatment, vacations, life insurance, transportation, the rental value of a home owned by the taxpayer, and the value of services provided by the taxpayer or a member of the taxpayer's household. This response correctly indicates that food consumed in the home may be considered in determining whether the taxpayer has contributed more than one-half the cost of maintaining the household.

Time On Task: 3 minutes 12) Answer: d Title: Multiple Choice Question 12 Difficulty: Medium Learning Objective 1: 4.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.4 Solution: The correct answer is 2026—Qualifying widow(er); 2027—Head of Household.

In the year of death, 2024, Trina files as married filing jointly. In the next two tax years, 2025 & 2026, Trina can file as qualifying widow(er) because she is providing more than half of the cost of maintaining the household for a dependent child, stepchild, or adopted child. In 2027, Trina can file as head of household because she has not remarried and is providing more than half the cost of maintaining a home for a qualifying child or qualifying relative.

Time On Task: 5 minutes 9

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13) Answer: c Title: Multiple Choice Question 13 Difficulty: Medium Learning Objective 1: 4.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.5 Solution: The correct answer is $5,450.

A limited standard deduction is available for Josiah because he is a dependent on his parents’ tax return. The limited standard deduction is the greater of: 1. $1,300 (2024) or 2. Earned income + $450 (2024) not to exceed the standard deduction of $14,600 (2024) Josiah’s earned income is $5,000 so his limited standard deduction is $5,450 ($5,000 + $450).

Time On Task: 4 minutes 14) Answer: d Title: Multiple Choice Question 14 Difficulty: Medium Learning Objective 1: 4.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.5 Solution: The correct answer is Both Amos's rate and parents' rate.

Because Amos has received earned income and unearned income in excess of $2,600 (2024), a portion will be taxed at Amos’s tax rate and the net unearned income will be taxed at his parents’ rate.

Time On Task: 3 minutes 15) Answer: d Title: Multiple Choice Question 15 Difficulty: Medium Learning Objective 1: 4.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.6 10

Solution: The correct answer is $32,300 The couple files a joint return and has a regular standard deduction of $29,200 plus $1,550 for each spouse for being 65 or older.

Time On Task: 3 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 4.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.1 Solution: Greg and Jan can claim 2 dependents. Ben is under the age of 24 and a full-time student. Ben did not provide more than 50% of his own support. Scholarships are not considered income for the support test. Kelly is under the age of 18 and does not provide greater than 50% of her own support. The other tests are assumed to be met so both Ben and Kelly are qualifying children.

Time On Task: 4 minutes 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 4.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.1 Solution: The $3,000 of wages that Osrie did not spend on his support are not included in the support test, nor are the nontaxable scholarships. Total support provided for Osrie is: Osrie’s wages Osrie’s mother Gambling winnings Osrie’s grandmother Total support

$ 6,000 7,000 1,500 4,000 $18,500

Support provided by Osrie ($6,000 + $1,500) = 40.5% Total support by and for Osrie ($18,500) Osrie did not provide more than 50% of his own support.

Time On Task: 5 minutes 11

3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 4.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.2 Solution: Davante can claim Shay as a dependent as he qualifies as a qualifying child. Shay is under the age of 19, attends school full-time, and did not provide more than 50% of his own support. The gross income test is not required for a qualifying child. Davante provides more than 50% support for Sterling, but Sterling fails the gross income test because he earns $23,000 which is not less than $5,050 (2024) so Sterling is not a qualifying relative.

Time On Task: 4 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 4.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.2 Solution: Both Kyle and Jason qualify as dependents as qualifying children, as they meet the relationship test, residency test, and the not self-supporting test. Francis does not qualify as a qualifying child because he is Derrick’s cousin and fails the relationship test. Also, Francis did not live with Derrick the entire year so he fails the relationship test for a qualifying relative.

Time On Task: 4 minutes 5) Title: Brief Exercise 5 Difficulty: Easy Learning Objective 1: 4.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.3 Solution: In the year of death (2024), Carolina can file as married filing jointly.

Time On Task: 2 minutes 6) Title: Brief Exercise 6 12

Difficulty: Easy Learning Objective 1: 4.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 4.4 Solution: Terry can be charged a fine of $635 (2024) per failure if the preparer does not exercise due diligence in determining if a taxpayer is eligible to file as head of household.

Time On Task: 2 minutes 7) Title: Brief Exercise 7 Difficulty: Medium Learning Objective 1: 4.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.5 Solution: Because Yu is a dependent on his parents’ tax return, he can use the limited standard deduction.

The limited standard deduction is the greater of $1,300 (2024) or earned income plus $450 (2024) limited to the regular standard deduction. Yu will be limited to the regular standard deduction of $14,600 because his earned income ($14,250) plus $450 is $14,700 and exceeds the regular standard deduction.

Time On Task: 4 minutes 8) Title: Brief Exercise 8 Difficulty: Medium Learning Objective 1: 4.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.5 Solution: Unearned income Earned income Total income Less: Standard deduction Taxable income Taxed at parent’s rate Taxed at child’s rate Time On Task: 5 minutes

$ 1,300 5,000 $ 6,300 ( 5,450) (Earned income + $450) $ 850

$

0 (The portion of unearned income > $2,600) 850

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9) Title: Brief Exercise 9 Difficulty: Medium Learning Objective 1: 4.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.6 Solution: LaToya is required to file a tax return because her income of $3,900 exceeds her assumed standard deduction of $0. The standard deduction is assumed to be $0 for determining whether she must file a tax return. When she actually files her tax return, her standard deduction will be $14,600 (2024), provided that her husband also uses the standard deduction on his married filing separately tax return. She must use the standard deduction if her husband also uses the standard deduction on his married filing separately tax return. If her husband itemizes his deductions, then she must also itemize.

Time On Task: 3 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Easy Learning Objective 1: 4.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.1 Solution: For tax years 2018-2025, the personal and dependency exemption deduction is zero for all taxpayers.

Time On Task: 2 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 4.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.1 Solution: Alyssa, Enrique, and Jenny all meet the qualifying child requirements. All three meet the age and support test. Alyssa is under the age of 24 and a full-time student and the gross income test does not apply. Even though Enrique is only a part-time student with earnings of $22,000, he is under

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the age of 19 so the gross income test is not required. Jenny has no income and meets the age and support test.

Time On Task: 5 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 4.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.1 Solution: a. The parent with whom the children stays the longest, Meg, is entitled to claim the children as dependents in the absence of any written agreement. b. Assuming the children reside with Meg the longest, she can waive the dependency claim to Roland by signing Form 8332. Roland must attach this form to the return to claim the children as dependents.

Time On Task: 5 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 4.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.2 Solution: Arabel is a qualifying child and can be claimed as a dependent on her parents’ income tax return.

Arabel is under the age of 24 and a full-time student and their child. Her parents provide more than 50% of her support. Colton does not qualify as a qualifying child because he fails the age test. He is also not a qualifying relative because he fails the gross income test ($5,600 is greater than $5,050). Arabel and Colton filed a joint return, but it is only to obtain a refund of their federal income tax withheld, so the joint return test is still met.

Time On Task: 6 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 4.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.2 Solution: 15

Esau, Ruby, Joshua, and Esther all qualify. Esau and Ruby meet the qualifying child requirements. Joshua is also considered a qualifying child because he meets the relationship test, age test, and not self-supporting test. He does not need to pass the gross income test to be a qualifying child. Esther is a qualifying relative. She meets the relationship test and support test.

She also meets the gross income test because the Social Security benefits are not taxable. Esther does not need to live with Abraham and Sarah because there is not a residence test for qualifying relatives.

Time On Task: 6 minutes 6) Title: Application Problem 6 Difficulty: Hard Learning Objective 1: 4.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.2 Solution: Kobe can only claim Trent as a dependent as a qualifying child. Kobe cannot claim Garret. He is not a qualifying child because even though he is under the age of 24, he is not a full-time student for at least five months. Garret attended college for only four months until he graduated. Garret can be considered for the qualifying relative rule. However, his earned income of $5,500 is not less than the exemption amount of $5,050 (2024) which disqualifies him from being a qualifying relative. The niece meets the qualifying relative requirements except that she filed a joint return with her new spouse, so she fails the joint return test. Therefore, Kobe cannot claim her as a dependent.

Time On Task: 6 minutes 7) Title: Application Problem 7 Difficulty: Hard Learning Objective 1: 4.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.2 Solution: The grandparents or the aunt can claim Felicia as a dependent on their tax returns under a multiple support agreement. The total support received was $9,000 ($1,300 dividend income + $2,200 Social Security benefits + $3,500 funds from grandparents + $1,500 funds from aunt + $500 funds from uncle). The Social Security benefits are nontaxable but are included in the support test if the recipient used the funds for support during the year. The grandparents and the aunt provide more than 10% support each and combined, provide more than 50% of the total support. The uncle provided only 5.6% ($500/$9,000). The uncle cannot claim Felicia because he did not provide more than 10% of the total support.

16

The grandparents and aunt meet the support test and one of them can be designated by the group to claim Felicia as a dependent. Note that the grandparents and aunt must also meet the other requirements to claim Felicia as a qualifying relative (relationship test, gross income test, jointreturn test, citizen test) which they do.

Time On Task: 6 minutes 8) Title: Application Problem 8 Difficulty: Easy Learning Objective 1: 4.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.3 Solution: Filing status is determined as of the last day of the taxable year. Because they are considered officially divorced as of December 30 and they did not have any dependents, they each must file as single.

Time On Task: 2 minutes 9) Title: Application Problem 9 Difficulty: Medium Learning Objective 1: 4.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.3 Solution: Daphne cannot use the standard deduction on her tax return. Married filing separately requires that the spouses divide income and expenses according to ownership. If one spouse itemizes, then the other spouse must itemize as well. If Huey itemizes then Daphne will have to do the same.

Time On Task: 4 minutes 10) Title: Application Problem 10 Difficulty: Medium Learning Objective 1: 4.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.2 Solution: Ella and Gerard can file as married filing joint if they both make an election to treat Gerard, a non-resident alien spouse, as a U.S. resident for income tax and withholding purposes.

17

Time On Task: 2 minutes 11) Title: Application Problem 11 Difficulty: Easy Learning Objective 1: 4.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.3 Solution: Lisbeth and Franco have a 2024 standard deduction of $29,200 for married filing jointly.

Time on Task: 2 minutes 12) Title: Application Problem 12 Difficulty: Hard Learning Objective 1: 4.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.3 Solution: Viktor qualifies as an innocent spouse for tax liability purposes and abandoned spouse for filing status. Viktor did not know about the underreported income or the skimming that resulted in a lawsuit. He can avoid the joint liability when income is omitted from the tax return if it was reasonable that he would not have known of the fraud. Viktor had no reason to suspect an omission of income and the error can be attributed to the other spouse. Viktor can use the abandoned spouse rules to file as head of household because he has met the two requirements needed: 1. Camille has not lived in the home for the last six months of the calendar year, and 2. Viktor provides more than half of the cost of maintaining a home for himself and Viktor Jr. Time On Task: 6 minutes 13) Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 4.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.4 Solution: a. Food provided for in the home

Both 18

b. Education costs including tuition, books, and fees c. You the parent provide yard maintenance for your home d. Swim lessons for your child e. Rent paid f. Food consumed at a restaurant g. Utilities paid Time On Task: 7 minutes

DEP Neither DEP Both DEP Both

14) Title: Application Problem 14 Difficulty: Medium Learning Objective 1: 4.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.4 Solution: Mariska’s filing status in the year of Elliot's death is automatically married filing joint. In Years 28 and 29, Mariska will qualify as a surviving spouse because she maintains a home for a dependent child and will file as qualifying widower with a dependent child. Qualifying widow(er) is advantageous over head of household because she can use the married filing joint rates in calculating her tax liability. Qualifying widow(er) is available for only the first two years after the year of death of the spouse. In Year 30, Mariska will qualify as head of household status because she is still providing more than half of the cost of maintaining a home for her children.

Time On Task: 4 minutes 15) Title: Application Problem 15 Difficulty: Medium Learning Objective 1: 4.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.4 Solution: a. Married filing jointly—The Navises are married as of the last day of the taxable year.

They could also chose to each file as married filing separately. b. Single—Because Curtis is not a dependent (the greater than 50% support test is failed), Randall’s filing status is single. c. Head of household—Nadiah can file as head of household even though her mother does not live with her because she provides over 50% of the cost of maintaining her mother’s home. Note that this exception to the head of household rules applies to parents only. d. Head of household—Vanessa can file as head of household because she provides more than 50% of the cost of maintaining a household for an unmarried qualifying child.

There is an exception to the head of household rule, which provides that if the 19

dependency right was waived by Vanessa, she can still file as head of household because she maintains a household for Reese and Reese live with her more than half of the year. e. Qualifying widow(er) —Len qualifies as a surviving spouse who can file as qualifying widow(er) with a dependent child if he provides more than 50% of the cost of maintaining a home for a dependent child. Qualifying widow(er) is available for only the first two years after the year of death of the spouse. f. Head of household—Arthur meets the definition of an abandoned spouse so he can file as head of household.

Time On Task: 10 minutes 16) Title: Application Problem 16 Difficulty: Hard Learning Objective 1: 4.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.4 Solution: Irene qualifies for head of household status. Ralph is considered a qualifying child and dependent because Irene has provided more than half of the cost of maintaining a home for Ralph and he has lived with her for more than half of the year. Adopted children meet the relationship test. Dirk does not qualify as a qualifying relative because he is not related to her and he did not live with Irene the entire year. Pat is considered a qualifying relative because she meets the relationship test, the support test, and the gross income test (less than $5,050 was earned).

Time On Task: 8 minutes 17) Title: Application Problem 17 Difficulty: Medium Learning Objective 1: 4.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.4 Solution: Faith qualifies for head of household status. Hope is considered a qualifying child and dependent because Faith has provided more than half of the cost of maintaining a home for Hope and she has lived with Faith for more than half of the year. Joy is considered a qualifying relative because she meets the relationship test, the support test, and the gross income test (less than $5,050 was earned). Child support is not considered taxable income.

Time On Task: 6 minutes 18) 20

Title: Application Problem 18 Difficulty: Medium Learning Objective 1: 4.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.5 Solution: Because Talen is a dependent on his parents’ income tax return, he can deduct a limited standard deduction on his return equal to the greater of: 1. basic standard deduction $1,300, or 2. earned income plus $450. a. Talen has a standard deduction of $1,450 ($1,000 earned income + $450). b. Talen has a standard deduction of $1,300 (basic standard deduction) because he did not have any earned income. c. Talen has a standard deduction of $7,050 ($6,600 earned income + $450). d. Talen has a standard deduction of $14,600. His standard deduction cannot be greater than the regular standard deduction for a single filer.

Time On Task: 8 minutes 19) Title: Application Problem 19 Difficulty: Medium Learning Objective 1: 4.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.5 Solution: The kiddie tax rules apply to Kerry because he is under 18 and has unearned income of more than $2,600. The kiddie tax rules do not apply to Edward because even though he is a full-time student under 24 with unearned income in excess of $2,600, he provides more than 50% of his own support.

Time On Task: 6 minutes 20) Title: Application Problem 20 Difficulty: Hard Learning Objective 1: 4.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.5 Solution: 21

Unearned income Earned income Total income Less: Standard deduction Taxable income Taxed at parents’ rate: (Unearned income > $2,600) Taxed at child’s rate Time On Task: 12 minutes

a. $1,000 500 $1,500 (1,300) $ 200

b. $ 500 900 $1,400 (1,350) $ 50

c. $ 4,200 10,000 $14,200 (10,450) $ 3,750

d. $ 3,800 15,500 $19,300 (14,600) $ 4,700

$ 0 $ 200

$ $

$ 1,600 $ 2,150

$ 1,200 $ 3,500

0 50

21) Title: Application Problem 21 Difficulty: Medium Learning Objective 1: 4.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.6 Solution: a. The correct standard deduction for Bert and Betty is $32,300 ($29,200 + $1,550 + $1,550). b. The correct standard deduction for Sandy is $16,550 ($14,600 + $1,950 blind). c. The correct standard deduction for Brittany is $21,900. Brittany does not receive an additional standard deduction for her daughter who is blind. d. The correct standard deduction for Peter is $14,600.

Time On Task: 8 minutes 22) Title: Application Problem 22 Difficulty: Medium Learning Objective 1: 4.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 4.6 Solution: a. Yes, Balaji’s income of $8,400 is less than the standard deduction for being single ($14,600), but his self-employment income is $400 or more so Balaji must file. b. No, Jenny and Jeremy's income of $25,500 is less than their total standard deduction of $30,750 ($29,200 SD + $1,550 for age).

22

c. Yes, Manxue’s income of $15,000 is greater than her regular standard deduction of $14,600.

The additional standard deduction for being blind is not taken into consideration when determining whether she needs to file a tax return. d. Yes, Elaine’s income of $24,000 is greater than her total standard deduction of $23,850 ($21,900 + $1,950 for age) Time On Task: 8 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Difficult Learning Objective 1: 4.2 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 4.2 Solution: None of them can be a qualifying child because none live in Jacob’s household. Only the niece qualifies as a qualifying relative. The cousin and friend do not meet the relationship test, and they do not live in his household for the entire year, so they do not qualify as dependents. The niece does not have to live in his household, and she does meet all the other tests as a qualifying relative.

Time On Task: 6 minutes 2) Title: Tax Planning Problem 2 Difficulty: Medium Learning Objective 1: 4.3 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 4.3 Solution: If John and Mary want to file as married filing jointly, then they must wait to divorce until after December 31.

Time On Task: 4 minutes 3) Title: Tax Planning Problem 3 Difficulty: Difficult Learning Objective 1: 4.6 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis 23

Section Reference 1: 4.6 Solution: Savannah is not required to file a tax return because her income of $10,500 is less than her standard deduction of $14,600. However, because federal and state income tax was withheld from her paycheck, she should file a return to request the refund of taxes withheld.

Time On Task: 4 minutes Professional Development Skills Communication Problem 1) Title: Communication Problem: Multiple Caregivers Difficulty: Medium Learning Objective 1: 4.2 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 4.2 Solution: Memo to Client Hello Elijah, Ben, and Amy, Thank you for allowing me to assist in determining if any of you can claim your mother, Hazel, as a dependent on your tax return. I have a strategy that will help two of you. The total support provided to Hazel was $26,350 of which the three of you have provided over 50% together, but none of you provided more than 50% individually. You may file a Multiple Support Agreement, Form 2120, which allows a group of individuals who collectively provide more than 50% of a taxpayer’s support to designate which member of the group will claim Hazel as a dependent. The individuals must also meet the other tests to claim a dependent. Unfortunately, Amy cannot participate in the agreement because she contributed only 5.69% of Hazel’s support ($1,500/$26,350) and more than 10% is needed to be eligible. Only financial support can be considered for this test; time spent with the taxpayer is not considered. Elijah and Ben can complete Form 2120 and alternate claiming Hazel on their tax returns each year. You must attach the form to your tax return in the year that you are claiming the exemption.

Please let me know if you need any further assistance or clarification.

Sincerely, Carnes & Youngberg, CPAs Tax memo to the file Facts: Elijah, Ben, and Amy help take care of their mother, Hazel, who moved into a nursing home this year. They provide you with the following information: 24

Interest income—Hazel Dividend income—Hazel Taxable pension—Hazel Funds from Elijah Funds from Ben Funds from Amy

$ 850 $1,500 $7,000 $9,500 $6,000 $1,500

Amy spends significant time with her mother and thinks this should be considered in the analysis.

Issue: Which of these individuals may claim a dependency exemption for Hazel, if any?

Conclusion: Elijah and Ben can designate one of them to claim their mother as a dependent on a multiple support agreement. Amy cannot be considered because she did not provide more than 10% of the total financial support.

Analysis: The total support provided to Hazel totaled $26,350 of which the three children provided over 50% together, but none provided more than 50% individually. Therefore, individually, none are eligible to claim Hazel as a dependent. IRC Reg. §1.152-3(a)(3) states that an individual must provide more than 10% to be considered eligible to participate in the Multiple Support Agreement. Therefore, Amy is not eligible to claim Hazel as a dependent. Both Elijah and Ben are eligible because each provided more than 10% of the total support and in total provided more than 50%. Form 2120 will be completed each year by Elijah and Ben, and they can alternate which one claims Hazel as a dependent. The form must be attached to the tax return in the year that each one claims Hazel as a dependent.

Time On Task: 15 minutes Ethics Problem 1) Title: Ethics Problem: Liable or Innocent Spouse Difficulty: Hard Learning Objective 1: 4.3 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 4.3 Solution: A spouse can avoid joint liability when income is omitted from a joint tax return if the spouse qualifies as an innocent spouse. The taxpayer must have had no knowledge of the income or omission and the tax underpayment must be attributed to the other spouse. It is clear that the income and omission are attributable to Stella, but Finn has received the benefit of the extra income generated.

25

Finn must establish that at the time he signed the joint return, he did not know—and had no reason to know—that there was an understatement of tax. Under IRS Publication 971, Innocent Spouse Relief, a taxpayer knew or had reason to know of an understated tax if: 1. The taxpayer knew of the understated tax, or 2. A reasonable person in similar circumstances would have known of the understated tax.

Six factors are listed in determining if a taxpayer should have known of the erroneous item (underreported income). One factor is whether the taxpayer failed to ask, at or before the time he signed the return, about items on the return or omitted from the return that a reasonable person would question. Finn should have noticed that no additional income was reported on the tax returns that would account for the increased level of lifestyle that he benefitted from. With his level of education, he should have known that additional income would be needed to afford such a lavish home as well as the expensive car and multiple vacations.

Given the facts and benefits received by Finn, he should have been aware of the increase in disposable income over 2021 and 2022 and is not eligible for innocent spouse relief.

Time On Task: 15 minutes Research Problem 1) Title: Research Problem: Who May Claim Child as Dependent?

Difficulty: Difficult Learning Objective 1: 4.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 4.1 Solution: Shantel is eligible to claim Xander as her dependent as a qualifying child. However, under I.R.C. §152(c)(4)(C), “if the parents of an individual may claim such individual as a qualifying child but no parent so claims the individual, such individual may be claimed as the qualifying child of another taxpayer but only if the adjusted gross income of such taxpayer is higher than the highest adjusted gross income of any parent of the individual.”

Because Shantel’s parents’ income is greater than Shantel’s, if Shantel does not claim Xander as a dependent, then Shantel’s parents can claim Xander. This will be more advantageous because Shantel is below the filing requirement regardless of whether she is single or head of household.

She would only file a tax return in order to receive her income tax withheld back from the government. Also, the child tax credit of $2,000 can be received in full by the grandparents because of their higher AGI which is still below any phase-out range. Shantel would only receive the refundable portion of the child tax credit of $1,700 (2024) if she had claimed Xander.

Time On Task: 15 minutes Excel Problems 26

[[ED TO WILEYPLUS CODERS: See submitted Excel file "Carnes_Individual_Ch04_SM_Excel_Problem_2024_Update_Pub1304_2020_data.xlsx" for data tables & graphs for Excel problems 1 & 2.]]

1) Title: Excel Problem 1: Determine Returns Filed by Filing Status Difficulty: Medium Learning Objective 1: 4.3, 4.4 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 4.3, 4 Solution: Input Area Table 1.3: Married Filing Jointly/Surviving Spouse

55,322,922

33.66%

Married Filing Separately

3,919,416

2.38%

Head of Household

21,463,538

13.06%

Single

83,652,916

50.90%

Total Input Area Table 1.3: Married Filing Jointly/Surviving Spouse Married Filing Separately Head of Household Single Total

164,358,792

100.00% =+TBL1.3!D8 =+TBL1.3!F8 =+TBL1.3!H8 =+TBL1.3!J8 =SUM(B4:B7)

=+B4/B$8 =+B5/B$8 =+B6/B$8 =+B7/B$8 =SUM(C4:C7)

[[COMP: Replace "Chart 1.3" in the chart below with the title: "Percentage of Individual tax returns by filing status". See submitted Excel file "Carnes_Individual_Ch04_SM_Excel_Problem_2024_Update_Pub1304_2020_data.xlsx"]]

27

Chart 1.3 34% 51%

2% 13% Married Filing Jointly/Surviving Spouse Married Filing Separately Head of Household Single Time On Task: 20 minutes 2) Title: Excel Problem 2: Determine Returns Filed by Age and Income Difficulty: Medium Learning Objective 1: 4.5 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 4.5 Solution: Input Area Table 1.6: No Adjusted Gross Income

60,506

3.22%

>=$1 and <$5k

1,003,392

53.39%

>=$5k and <$10k

502,020

26.71%

>=$10k and <$15k

196,537

10.46%

>=$15k and <$20k

63,440

3.38% 28

>=$20k and <$25k

25,242

1.34%

>=$25k and <$30k

9,507

0.51%

>=$30k and <$40k

4,010

0.21%

>=$40k and <$50k

-

0.00%

>=$50k and <$75k

6,993

0.37%

>=$75k and <$100k

2,958

0.16%

>=$100k and <$200k

2,034

0.11%

>=$200k and <$500k

2,390

0.13%

>=$500k and <$1m

329

0.02%

>=$1m and <$1.5m

-

0.00%

>=$1.5m and <$2m

-

0.00%

>=$2m and <$5m

56

0.00%

>=$5m and <$10m

-

0.00%

>=$10m

3

0.00%

Total

1,879,417

Input Area Table 1.6: No Adjusted Gross Income >=$1 and <$5k >=$5k and <$10k >=$10k and <$15k >=$15k and <$20k >=$20k and <$25k >=$25k and <$30k >=$30k and <$40k >=$40k and <$50k >=$50k and <$75k >=$75k and <$100k >=$100k and <$200k >=$200k and <$500k

100.00%

=+TBL1.6!C11 =+TBL1.6!D11 =+TBL1.6!E11 =+TBL1.6!F11 =+TBL1.6!G11 =+TBL1.6!H11 =+TBL1.6!I11 =+TBL1.6!J11 =+TBL1.6!K11 =+TBL1.6!L11 =+TBL1.6!M11 =+TBL1.6!N11 =+TBL1.6!O11 29

=+B12/B$31 =+B13/B$31 =+B14/B$31 =+B15/B$31 =+B16/B$31 =+B17/B$31 =+B18/B$31 =+B19/B$31 =+B20/B$31 =+B21/B$31 =+B22/B$31 =+B23/B$31 =+B24/B$31

>=$500k and <$1m >=$1m and <$1.5m >=$1.5m and <$2m >=$2m and <$5m >=$5m and <$10m >=$10m Total

=+TBL1.6!P11 =+TBL1.6!Q11 =+TBL1.6!R11 =+TBL1.6!S11 =+TBL1.6!T11 =+TBL1.6!U11 =SUM(B12:B30)

=+B25/B$31 =+B26/B$31 =+B27/B$31 =+B28/B$31 =+B29/B$31 =+B30/B$31 =SUM(C12:C30)

[[COMP: Replace "Chart 1.6" with "Tax returns filed by Individuals under age 18 and the amount of income generated."

Carnes_Individual_Ch04_SM_Excel_Problem_2024_Update_Pub1304_2020_data.xlsx The file has a better, cleaner version of the pie chart shown here. For the SM we want the better version used.]]

10%

Chart 1.6 3%1% 3%

53%

27% No Adjusted Gross Income

>=$1 and <$5k

>=$5k and <$10k

>=$10k and <$15k

>=$15k and <$20k

>=$20k and <$25k

>=$25k and <$30k

>=$30k and <$40k

>=$40k and <$50k

>=$50k and <$75k

>=$75k and <$100k

>=$100k and <$200k

>=$200k and <$500k

>=$500k and <$1m

Time On Task: 20 minutes CPA Exam Preparation: Task-Based Simulation 1) 30

Title: Task-Based Simulation: Dependents Difficulty: Medium Learning Objective 1: 4.1, 4.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 4.1, 2 Solution: Dependents Situation Dependent name QC/QR a.

Zach and Misty QC b.

None Neither c.

Betty QR d.

Corinne QC e.

None Neither f.

Arline QR g. With respect to Darryl None Neither h.

Dustin QC i.

Tabitha QC j.

Trey QC Rationale for Answers: a. Zach and Misty meet the QC tests. For Yuliya to be a QR, she would have to be a member of the household for the entire taxable year because she does not meet the relationship test. b. Nell's gross income from the rental property is not less than the 2024 exemption amount, $5,050. Gross income is generally defined as revenue less cost of goods sold, but it is not reduced for other expenses. c. Betty is a QR because Jeff provides over 50% of her support. A QR does not have to live in your home, but you must provide more than 50% of the dependent’s total support. d. Corinne meets the age test for a QC because she is a full-time student and is less than 24. She also does not provide more than 50% of her own support, so she meets the QC requirements. e. Corinne does not meet the age test because she is 24 or older. Therefore, she is not a QC. She does not meet the QR test because her gross income is not less than the exemption amount of $5,050 for 2024. Therefore, her parents, nor her grandparents, can claim her as a dependent. If Corinne had met the gross income test, she would qualify as a dependent for her parents (40%) or grandparents (20%) only if a multiple support agreement is filed. f. As long as a multiple support agreement is filed, any of the children could claim her as a QR because each contributed more than 10% of Arline's total support.

31

g. Custodial parent receives the exemption, unless the divorce agreement provides otherwise.

Because Daryl has transferred this right to Joanne, he cannot claim Marquese as a dependent. h. Dustin is a qualifying child. Note that the definition of a QC includes siblings, nieces and nephews, and grandchildren. Dustin meets the age test for a QC because he is a full-time student and is less than 24. He also does not provide more than 50% of his own support. i. Tabitha is a QC. j. Trey is a QC. Time On Task: 20 minutes 2) Difficulty: Medium Learning Objective 1: 4.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 4.5 Solution: Kiddie Tax Scenarios Unearned income Earned income Total Less: Standard deduction

One $3,100 0 $3,100 (1,300)

Two $ 800 1,000 $1,800 (1,450)

Three $ 3,500 13,500 $17,000 (14,600)

Taxable income

$1,800

$ 350

$ 2,400

Taxed at Parent’s rate $ 500 (Unearned income>$2,600) Taxed at Child’s rate $1,300 Time On Task: 15 minutes

0

$ 900

$ 350

$ 1,500

32

Chapter 5—Framework for Income Recognition End of Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Medium Learning Objective 1: 5.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.1 Solution: Realized income and recognized income are different. Realized income occurs when all events have occurred to complete the earnings process. Recognized income means that the realized income must be included in the computation of taxable income. Realized income is the excess of the proceeds from the sale over the cost basis (or adjusted cost basis). Some realized gains/losses are deferred and recognized at a later date, while some are excluded and never recognized.

Time On Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Medium Learning Objective 1: 5.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.1 Solution: Nadia does need to report income on her tax return. The vegetables received are a form of receipt and Nadia must report the vegetables’ fair market value as revenue.

Time On Task: 2 minutes 3) Title: Discussion Question 3 Difficulty: Medium Learning Objective 1: 5.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.1 Solution: Both Suzanne and Bill have reportable income. They both performed a service in exchange for a service. Suzanne must report the fair market value of the tennis lessons received and Bill must report the fair market value of the tax return service received.

5-1

Time On Task: 2 minutes 4) Title: Discussion Question 4 Difficulty: Medium Learning Objective 1: 5.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.2 Solution: According to the assignment of income doctrine, income is taxed to the individual who earned the income, even if the taxpayer directs that the funds be paid to someone else. Eric seems qualified to perform general office work and should be paid accordingly. It appears that Mark is trying to assign income from himself to his son to lower the overall tax liability between the two parties. Mark may pay Eric a reasonable salary and legitimately shift income from Mark to Eric, but $100,000 is not likely to be a reasonable amount to pay Eric.

Time On Task: 3 minutes 5) Title: Discussion Question 5 Difficulty: Easy Learning Objective 1: 5.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.2 Solution: Under the constructive receipt doctrine, Drew must report his income in Year 11. The income was unconditionally available to him and there were no restrictions on his control of the income.

Drew chose to deposit the check in Year 12.

Time On Task: 2 minutes 6) Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 5.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.2 Solution: The claim of right doctrine provides that when property or funds are received due to a mistake of fact or law, the amount received is included in the recipient's gross income regardless of whether the recipient is obligated to return the item to the payer when the error is discovered. If there are no restrictions on the taxpayer’s use of the income and the taxpayer does not currently have an

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obligation to repay the amount, the taxpayer includes the amount in income. If the amount must be repaid in the future, the taxpayer will receive a deduction at that time.

Time On Task: 3 minutes 7) Title: Discussion Question 7 Difficulty: Medium Learning Objective 1: 5.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.2 Solution: Under the tax benefit rule, a taxpayer must include in income any payment received in which the taxpayer received a tax benefit through a deduction in a prior year. If the taxpayer was unable to itemize their deductions in a prior year, then no benefit was received from the state income tax paid in the prior year. Therefore, the taxpayer will not have to include in income the state tax refund received in the following year.

Time On Task: 3 minutes 8) Title: Discussion Question 8 Difficulty: Easy Learning Objective 1: 5.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.3 Solution: An individual can use the cash method to report business income from a sole proprietorship unless the average gross receipts over the previous three tax years exceeds $30 million (2024). If the average is more than $30 million, then the taxpayer must use the accrual method.

Time On Task: 2 minutes 9) Title: Discussion Question 9 Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.3 Solution: Under the cash method, taxpayers recognize income in the period they receive cash, property, services, or other benefits in an economic transaction that is taxable. The accrual method of accounting recognizes income when all the events have occurred that fix their right to receive

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that income and the amount of that income can be determined with reasonable accuracy. It records expenses when liabilities are incurred regardless of when cash is received or paid.

Time On Task: 4 minutes 10) Title: Discussion Question 10 Difficulty: Easy Learning Objective 1: 5.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.3 Solution: Taxpayers cannot use the installment method for property held for sale in the ordinary course of business, nor for sales of stock or securities traded on an established securities market.

Time on Task: 2 minutes 11) Title: Discussion Question 11 Difficulty: Easy Learning Objective 1: 5.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.3 Solution: Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

Time On Task: 2 minutes 12) Title: Discussion Question 12 Difficulty: Easy Learning Objective 1: 5.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.3 Solution: Form 3115 is used to make a request to change an accounting method.

Time On Task: 2 minutes 13) Title: Discussion Question 13 Difficulty: Easy Learning Objective 1: 5.4

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Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.4 Solution: Income from sole proprietorships and single-member limited liability companies (SMLLC) that are owned by an individual is reported on Schedule C, Profit or Loss from Business (Sole Proprietorship).

Time On Task: 2 minutes 14) Title: Discussion Question 14 Difficulty: Easy Learning Objective 1: 5.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.4 Solution: Schedule E, page 1 is used to report an individual’s rental property activity.

Time on Task: 1 minute 15) Title: Discussion Question 15 Difficulty: Easy Learning Objective 1: 5.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.5 Solution: A specified service business activity is any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of an employee or owner.

Time On Task: 3 minutes Multiple Choice Questions 1) Answer: e Title: Multiple Choice Question 1 Difficulty: Medium Learning Objective 1: 5.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting

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Standard 3: Bloom's || Application Section Reference 1: 5.1 Solution: The correct answer is All of these are correct.

All are acceptable forms of payment. The recipient would include in income the fair market value of the payment. Options a, c, and d are receipt for services performed and option b is for payment of product sold. See Chapter 8, LO2, Disallowance of Deductions, for disallowance of expenses paid in an illegal drug business.

Time On Task: 4 minutes 2) Answer: c Title: Multiple Choice Question 2 Difficulty: Medium Learning Objective 1: 5.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.2 Solution: The correct answer is II and III only.

The constructive receipt doctrine applies to II and III. The income was unconditionally available to her and there were no restrictions on her control of the income.

Time On Task: 4 minutes 3) Answer: d Title: Multiple Choice Question 3 Difficulty: Medium Learning Objective 1: 5.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.2 Solution: The correct answer is $405.

The tax benefit rule applies to the $400 and the interest is taxable.

Time On Task: 3 minutes 4) Answer: d Title: Multiple Choice Question 4 Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting

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Standard 3: Bloom's || Application Section Reference 1: 5.3 Solution: The correct answer is $53,333 in Year 22 and $346,667 in Year 23.

Juan must use the installment method to report the sale of the apartment building. There is no depreciation recapture in this case. The gain recognized each year equals: Payments received each year  Gross profit/Contract price Year 22: $100,000  $400,000/$750,000 = $53,333 Year 23: $650,000  $400,000/$750,000 = $346,667 Interest income will also be reported on Schedule B. Time On Task: 5 minutes 5) Answer: d Title: Multiple Choice Question 5 Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.3 Solution: The correct answer is If the change is initiated by an Internal Revenue Service examination and it increases income, 100% of the change must be included in income for the year of the change.

A taxpayer may voluntarily request a change in accounting method. If it results in an increase in income and liability, the liability may be paid over four years. If the IRS initiates the change that results in an increase in income, the increase in income must be included in the year of the change. The IRS provides automatic consent for some changes. For such changes, once the Form 3115 is correctly filed, then the consent is deemed to have taken place. For nonautomatic changes, the taxpayer must wait for the IRSʼs written consent before making the change.

Time On Task: 4 minutes 6) Answer: a Title: Multiple Choice Question 6 Difficulty: Easy Learning Objective 1: 5.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.4 Solution: The correct answer is C corporation.

A C corporation is a separate legal entity that is responsible for paying its own tax.

Time On Task: 1 minute

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7) Answer: d Title: Multiple Choice Question 7 Difficulty: Easy Learning Objective 1: 5.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.4 Solution: The correct answer is Schedule E. Ordinary business income from Schedule K-1 is reported on Form 1040, Schedule E, page 2.

Time On Task: 1 minute 8) Answer: d Title: Multiple Choice Question 8 Difficulty: Medium Learning Objective 1: 5.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.5 Solution: The correct answer is Architecture.

Architecture is not considered a specified service activity in determining the QBI deduction.

Time On Task: 2 minutes 9) Answer: a Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.5 Solution: The correct answer is $0.

Since Cal’s modified taxable income exceeds $241,950, his specified service business generates zero QBI deduction. The wage/property limit does not apply in this example.

Time On Task: 3 minutes 10) Answer: c

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Title: Multiple Choice Question 10 Difficulty: Medium Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.5 Solution: The correct answer is $330,000.

Abe’s qualified business income from Lincoln, Inc. is $330,000. Qualified business income does not include wages received nor dividend income, if received.

Time On Task: 3 minutes 11) Answer: b Title: Multiple Choice Question 11 Difficulty: Medium Learning Objective 1: 5.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 5.5 Solution: The correct answer is It is a deduction from AGI on Form 1040 taken after the deduction for the greater of itemized deductions or the standard deduction.

The QBI deduction is a deduction from AGI and is the last deduction taken in determining taxable income.

Time On Task: 3 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 5.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.1 Solution: All the receipts are considered taxable income except answer g., which is not a taxable transaction. Answers a. and f. are for receipt of services rendered. Answer b. is income from bartering services. Answer c. is income due to debt forgiveness. Answers d. and e. are considered a treasure trove and taxable income.

Time On Task: 4 minutes

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2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 5.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.2 Solution: Sheldon would not have to report the lottery winnings until the following year. He did not have actual receipt of the money, and he does not constructively receive income if substantial limitations or restrictions exist on his use of the funds. Sheldon does have a substantial restriction because it is not expected that he travels to Florida to claim his prize in a one-day time period.

Time On Task: 3 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 5.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.2 Solution: Amir must report all $18,000 on his tax return as income. The assignment of income doctrine applies to property and provides that income from property is taxed to the owner of the property at the time the income accrued. Assuming the amount paid to Varun is considered reasonable compared to similar services provided by a similar company, Amir can take a deduction for compensation paid to Varun as a reasonable business expense.

Time On Task: 3 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.3 Solution: Declan must report gain of $1,600 for the land and $6,000 for the partnership interest. A taxpayer does not have to recognize income to the extent the amounts received are a return of the amount that the taxpayer paid for goods or investment under the recovery of capital doctrine.

Time On Task: 3 minutes

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5) Title: Brief Exercise 5 Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.3 Solution: Annabelle must report the following: Amount realized $281,250 Less: Adjusted basis (56,250) Gross profit $225,000 Installment gain: Gross profit percentage = Gross profit (225,000)/Contract price ($281,250) = 80% Payment received in year 1 = $71,250 Gain recognized in year 1 = $57,000; ($71,250  80%) Gain recognized in years 2–4 = $56,000; ($70,000  80%) Time On Task: 5 minutes 6) Title: Brief Exercise 6 Difficulty: Medium Learning Objective 1: 5.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.4 Solution: Casper will report all three activities on Schedule E. The rental income of $57,000 will be reported on Schedule E, page 1 and the partnership loss and S corporation income will be netted to reflect net income from flow through activities of $44,000 on Schedule E, page 2.

Time On Task: 3 minutes 7) Title: Brief Exercise 7 Difficulty: Easy Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.5 Solution:

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Enid’s qualified business income is $82,000 ($88,000 – $6,000). Enid reduces her QBI by the self-employed health insurance deduction.

Time On Task: 2 minutes 8) Title: Brief Exercise 8 Difficulty: Medium Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.5 Solution: Theo’s modified taxable income can be calculated as follows: AGI − Standard deduction – Qualified dividend income = Modified taxable income

AGI ($118,000 +4,400) Less: Standard deduction Less: Qualified dividend income Modified taxable income

$122,400 (14,600) (4,400) $103,400

QBI deduction is calculated as the lesser of: • •

20%  QBI = 20%  $118,000 = $23,600 20%  modified taxable income = 20%  $103,400 = $20,680

In this case, Theo’s qualified business income deduction would be $20,680.

Time On Task: 5 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium Learning Objective 1: 5.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.1 Solution: Receipts a. and b. are considered a form of payment and must be included in income. Receipt c. is an increase in wealth realized when the taxpayer puts the $500 in her pocket which is recognized as income under the treasure trove principle. Receipt d. is not income because the

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gain is not realized. When the mutual fund value increases, the taxpayer has an increase in wealth, but it will not be realized and recognized until he sells the mutual fund.

Time On Task: 4 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 5.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.2 Solution: Some factors to consider include age, experience, difficulty, level of education needed to complete the task, geographic location, and reasonable hourly rate for similar work.

Time On Task: 3 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 5.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.2 Solution: a. Damian must report the $1,000 in Year 1. Damian is a cash-basis taxpayer and actually received the income in Year 1. That he didn't use the income until January of Year 2 has no effect on the income being reported in Year 1. b. Hisham’s income will be increased by his salary received in year 1 of $3,500,000 ($7,000,000  50%) and for the actual cash signing bonus received of $500,000. Hisham never had a legally enforceable right to the $1,000,000 initially offered, because he did not accept that offer during the negotiation.

Time On Task: 6 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 5.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.2 Solution: a. Juliette has a claim of right to the income in Year 4 so she must report it as income that year.

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b. The dispute was resolved, and Juliette returned the $12,000 of income to the customer in Year 5. The $12,000 payment to the customer in Year 5 would result in an ordinary and necessary business deduction in Year 5.

Time On Task: 4 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 5.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.2 Solution: Jana was able to itemize her deductions and received a medical expense deduction benefit of $1,850. When she received a reimbursement in the following year, Jana must include the reimbursement to the extent of the benefit received in the prior year. Jana must report $1,850 of the $3,200 reimbursement as income, provided that the total itemized deduction is at least $1,850 more than the total standard deduction for Jana's last year tax return.

Time On Task: 3 minutes 6) Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.3 Solution: Jensen’s loan to his brother is a personal activity so the cash method of accounting applies.

Therefore, Jensen recognizes the $800 of prepaid interest income in Year 1 when he receives it.

Time On Task: 2 minutes 7) Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.3 Solution: a. Under the cash method of accounting, Javi must recognize the entire payment of $4,050 as income upon receipt in Year 4.

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b. Under the accrual method of accounting, if Javi elects the deferral method to account for advance payments, he will recognize $225 ($4,050/18 months) of income he earned in December, Year 4. He can defer the remaining portion of the income because it is also being deferred for financial reporting. In Year 5, Javi would recognize the remaining $3,825 (rather than only the $2,700 related to Year 5) because he is not allowed to defer the prepayments for more than one year. If Javi does not elect the deferral method, he would recognize the entire prepayment of $4,050 as income upon receipt in Year 4.

Time On Task: 6 minutes 8) Title: Application Problem 8 Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.3 Solution: a.

Amount realized $1,200,000 Less: Adjusted basis (600,000) Gross profit $ 600,000 Installment gain: Gross profit percentage = Gross profit/Contract price = 50% ($600,000/$1,200,000) Payment received in year 1 = $300,000 Gain recognized in year 1 = $150,000; ($300,000  50%) Gain recognized in years 2–4 = $450,000 total: ($150,000 in each year) b. The interest income will be reported on Janessa’s Schedule B. Time On Task: 6 minutes

9) Title: Application Problem 9 Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.3 Solution: Amount Realized: Installment Note

$ 75,000

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Plus: Debt Relief Less: Adjusted Basis Gross Profit/Realized Gain

25,000 $100,000 (65,000) $ 35,000

Contract price is the sales price ($100,000) less seller’s debt assumed by the buyer ($25,000) = $75,000.

Installment gain: Gross profit percentage = Gross profit/Contract price = 46.67%; ($35,000/$75,000) Payment received in year 1 = $15,000 Gain recognized in year 1 = $7,000 ($15,000  46.67%) Gain recognized in years 2–5 = $28,000 total: ($7,000 in each year) Time On Task: 6 minutes 10) Title: Application Problem 10 Difficulty: Hard Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.3 Solution: Amount Realized: Installment Note Plus: Debt Relief Less: Adjusted Basis Gross Profit/Realized Gain

$ 75,000 25,000 $100,000 (20,000) $ 80,000

Contract price is the sales price ($100,000) less seller’s debt assumed by the buyer not to exceed the seller’s basis ($20,000) = $80,000.

Installment gain: Gross profit percentage = Gross profit/Contract price = 100%; ($80,000/$80,000) Noah received a $15,000 payment and the law assumes he received an additional payment of $5,000, the excess of the debt relief ($25,000) over Noah’s basis in the property ($20,000).

Payment received in year 1 = $20,000

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Gain recognized in year 1 = $20,000; ($20,000  100%) Gain recognized in years 2–5 = $60,000; ($15,000 in each year) Time On Task: 8 minutes 11) Title: Application Problem 11 Difficulty: Hard Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.3 Solution: Amount realized $100,000 Adjusted basis (50,000) Gross profit $ 50,000 $30,000 of the profit is treated as Section 1245 depreciation recapture and taxed as ordinary income. The remaining $20,000 is taxed as Section 1231 gain. The $30,000 ordinary income from the depreciation recapture is not eligible for installment reporting.

The $20,000 Section 1231 gain is eligible for installment reporting.

Installment gain: Gross profit percentage = Gross profit/Contract price = 20%; ($20,000/$100,000) Payment received in year 1 = $50,000 Gain recognized in year 1 = $10,000; ($50,000  20%) Section 1231 gain Gain recognized in year 2 = $10,000; ($50,000  20%) Section 1231 gain Total income recognized for the year of sale is $50,000, consisting of $10,000 from each installment payment (which is Section 1231 gain) and $30,000 of Section 1245 recapture (ordinary income).

Time On Task: 8 minutes 12) Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.3 Solution: a. Because California is a community property state, both Lily and Peter will report one half of the total income earned of $107,500 ($125,000 + $90,000/2).

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b. If they lived in Florida which is a common law state, Lily would report $125,000 and Peter would report $90,000.

Time On Task: 6 minutes 13) Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 5.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.4 Solution: The expenses must be prorated between personal use and rental because only 1,050 square feet of the property is used as rental real estate. The following would be reported on Schedule E: Rental income Less: Advertising Property taxes Mortgage interest paid Utilities Maintenance Depreciation Net rental profit Time On Task: 8 minutes

$22,000 (575) (1,729) (3,027) (1,977) (2,100) (5,500) $ 7,092

Direct business expense [$2,800  1,050 sq feet/1,700 sq feet] [$4,900  1,050 sq feet/1,700 sq feet] [$3,200  1,050 sq feet/1,700 sq feet] [$3,400  1,050 sq feet/1,700 sq feet] Business expense on rental portion

14) Title: Application Problem 14 Difficulty: Hard Learning Objective 1: 5.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.4 Solution: Because this is an advance payment of feed costs, the farmer's deduction in Year 2 for prepaid feed and seed is limited to 50% × $11,000 (all other farming costs excluding the prepaid feed and seed), or $5,500. The remaining $6,500 ($12,000 − $5,500) will be deducted in Year 3.

Time On Task: 5 minutes 15) Title: Application Problem 15 Difficulty: Easy Learning Objective 1: 5.5 Standard 1: AACSB || Analytic

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Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.5 Solution: Susan’s qualified business income is $92,935 ($100,000 – $7,065). Susan reduces her QBI by one half of the self-employment tax.

Time On Task: 2 minutes 16) Title: Application Problem 16 Difficulty: Medium Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.5 Solution: Roger’s QBI deduction is $25,000, the lesser of: • 20%  QBI = 20%  $125,000 = $25,000, or • 20%  modified taxable income = 20%  $140,400 = 28,080 Time On Task: 5 minutes 17) Title: Application Problem 17 Difficulty: Medium Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.5 Solution: Kate’s QBI deduction is $24,080, the lesser of: • 20%  QBI = 20%  $125,000 = $25,000, or • 20%  modified taxable income = 20%  $120,400 = $24,080 Time On Task: 5 minutes 18) Title: Application Problem 18 Difficulty: Medium Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.5 Solution:

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Jaewoo is not entitled to a QBI deduction in 2024 because his accounting firm is a specified service business and he and his spouse’s taxable income before the QBI deduction ($485,000) is greater than the $483,900 threshold for 2024.

Time On Task: 4 minutes 19) Title: Application Problem 19 Difficulty: Hard Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.5 Solution: a. Because Lexi’s taxable income of $270,400 exceeds the $191,950 phase in threshold by more than $50,000, the wage/property limit fully applies and is the greater of: • •

50% of the wages paid with respect to the qualified trade or business (50%  $15,000 = $7,500) or The sum of 25% of the wages paid in the trade or business plus 2.5% of any unadjusted basis immediately after the acquisition of all qualified property in the qualified trade or business.

(25%  $15,000 = $3,750 + 2.5% of qualified property ($0) = $3,750)

Lexiʼs QBI deduction is then computed as the lower of: • $145,000 × 20% = $29,000 or • Wage/property limitation of $7,500.

Therefore, the QBI deduction is limited to $7,500.

The final QBI deduction cannot exceed 20% × modified taxable income ($270,400), or $54,080, which it does not. b. Because Lexi’s taxable income of $270,400 exceeds the $191,950 phase in threshold by more than $50,000, the wage/property limit fully applies and is the greater of: • •

50% of the wages paid with respect to the qualified trade or business (50%  $15,000 = $7,500), or The sum of 25% of the wages paid in the trade or business plus 2.5% of any unadjusted basis immediately after the acquisition of all qualified property in the qualified trade or business:

(25%  $15,000 = $3,750 + $4,000 [2.5% of qualified property ($160,000)] = $7,750) Lexiʼs QBI deduction is then computed as the lower of:

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• $145,000 × 20% = $29,000 or • Wage/property limitation of $7,750.

Therefore, the QBI deduction is limited to $7,750.

The final QBI deduction cannot exceed 20% × modified taxable income ($270,400), or $54,080, which it does not.

Time On Task: 12 minutes 20) Title: Application Problem 20 Difficulty: Hard Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.5 Solution: a. We use the following process in this computation: The specified service limitation does not apply to Alexander. The modified taxable income of Alexander falls into the range (2024) shown in Column 2 of Illustration 5.5: Single

> $191,950 and < $241,950

This means that the specified services and wage/property limitations potentially need to be phased in. Therefore, the QBI deduction is computed as follows: 1. No reduction is necessary for this step because Alexander is not operating a specified trade or business, so the applicable percentage is not used to reduce the amounts.

20%  QBI = 20%  $145,000 = $29,000; the QBI deduction is $29,000.

2. Because Alexander is in Column 2 and the wages/property limitation is reducing the deduction, the general QBI deduction is used, but reduced as follows, but not to exceed $7,750, which is the greater of: • 50% Wages ($15,000) = $7,500 or • 25% Wages ($15,000) + 2.5% Property ($160,000) = $7,750 a. Determine the excess between the general 20% QBI deduction of $29,000 in part 1 above and the full wages/property limitation of $7,750 in part 2 above: $21,250 ($29,000 − $7,750). b. Determine the reduction ratio: Taxable income before the QBI deduction − Applicable threshold $100,000 (MFJ) or $50,000 (Others)

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$200,000 − $191,950 = 16.1% $50,000 c. Determine the reduction in the wages/property limitation: Excess $21,250 from part 2a  reduction ratio 16.1% from part 2b = $3,421 (rounded) 3. Determine the final QBI deduction amount: General 20% QBI deduction amount from 1 Less: Reduction from 2c Final QBI deduction amount

$29,000 ( 3,421) $25,579

4.The final QBI deduction cannot exceed 20% × modified taxable income ($200,000), or 40,000, which it does not.

b. The specified service limitation does apply now because Alexander is providing tennis lessons. The modified taxable income of Alexander falls into the range (2024) shown in Column 2 of Illustration 5.5: Single

> $191,950 and < $241,950

This means that the specified services and wage/property limitations potentially need to be phased in. Therefore, the QBI deduction is computed as follows: 1. If a taxpayer has qualified business income from a specified service trade or business, the taxpayer includes only the applicable percentage of QBI and adjusts the components of the wages/property limitation by the applicable percentage, as follows: a. Determine the applicable percentage.

Applicable Percentage = 100% =

Taxable income before the QBI deduction − Applicable threshold $100,000 (MFJ) or $50,000 (Others)

In Alexander’s example, because he is in a specified service trade or business: Applicable percentage = 100% −

$200,000 − $191,950 = 83.9% $50,000

b. Determine reduced components of QBI deduction. This can be determined as follows: 1. 20%  QBI  applicable percentage = 20%  $145,000  83.9% = $24,331

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2. But not in excess of the greater of: • 50%  wages ($15,000)  applicable percentage = $7,500  83.9% = $6,293, or • (25% × wages ($15,000)) + (2.5% × unadjusted basis of qualified property ($160,000))  83.9% = $6,502 Note: If the specified service limitation does not apply, then the amounts do not have to be reduced by the applicable percentage.

The reduced QBI deduction is $24,331 after reduction for the specified services limitation. The reduced wage/property limitation is $6,502.

2. Because Alexander is in Column 2 of Illustration 5.5 and the wages/property limitation is reducing the deduction, the general QBI deduction is used, but is reduced as follows: a. Determine the excess between the general 20% QBI deduction as reduced in 1 above ($24,331) and the full wages/property limitation ($6,502): $17,829 ($24,331 − $6,502). b. Determine Alexander’s reduction ratio: Taxable income before the QBI deduction − Applicable threshold $100,000 (MFJ) or $50,000 (Others) $200,000 − $191,950 = 16.1% $50,000 c. Determine the reduction in Alexander’s wages/property limitation: Excess from part 2a ($17,829)  reduction ratio (16.1%) = $2,870 3. Determine Alexander’s final QBI deduction amount: General 20% QBI deduction amount from 1 Less: Reduction from 2c Final QBI amount

$24,331 ( 2,870) $21,461

4. Finally, we check if Alexander’s final QBI deduction of $21,461 exceeds 20% × his modified taxable income ($200,000), or $40,000. Because it does not, Alexander’s final QBI amount remains $21,461. c. If Alexander’s taxable income had been $250,000, he would not have been entitled to any QBI deduction because his modified taxable income exceeded the $241,950 threshold for single taxpayers, and he was in a specified service business.

Time On Task: 20 minutes 21)

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Title: Application Problem 21 Difficulty: Medium Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 5.5 Solution: Unadjusted modified taxable income Net capital gains Qualified dividend income Adjusted modified taxable income  20% Overall limitation

$275,000 (5,000) (2,500) $267,500  20%, $ 53,500

Total QBI deduction is $58,000, but it is limited to $53,500.

Time on Task: 5 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Medium Learning Objective 1: 5.4 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 5.4 Solution: An S corporation is the best choice. Pamela can be a sole shareholder, make all the decisions, utilize her losses as a flow through entity against her income earned at the advertising agency, and have protection from creditors as a corporation.

Time On Task: 4 minutes 2) Title: Tax Planning Problem 2 Difficulty: Hard Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 5.5 Solution: Candy must allocate the loss in proportion to the other businesses' positive QBI amounts.

Treetop Decorations Adjustment = $27,273 [$45,000  ($100,000/$165,000)]

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Candy’s Cookies Adjustment = $17,727 [$45,000  ($65,000/$165,000)] Business Treetop Decorations Candy’s Cookies Candy’s Snow Supplies Business Treetop Decorations Candy’s Cookies Candy’s Snow Supplies

Adjusted QBI $72,727 ($100,000 − $27,273) $47,273 ($65,000 − $17,727) $ 0 QBI  20% $14,545 $ 9,455 $ 0

W-2 wages $12,500 $ 0 $ 5,000

W-2 wages  50% $6,250 $ 0 $2,500

Property $0 $0 $0 Lesser $6,250 $ 0 $ 0

Candy’s combined QBI Deduction = $6,250 which is less than $80,000 ($400,000 modified taxable income  20%). Note that the wage limitation is applied separately to each QBI activity.

Time On Task: 8 minutes Communication Problem 1) Title: Communication Problem: Installment Sale Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 5.3 Solution: Memo to Client: Hello Zian, Thank you for allowing me to prepare your 2024 tax return and discuss the tax results from the sale of your apartment building. You will need to report the sale on your 2024 tax return, but you will not need to pay tax on the gain in 2024.

Because Ace will make five payments beginning in 2025, this sale is an installment sale. Under the installment sale rules, you will report and recognize a portion of the realized gain in each year beginning in 2025. The total realized gain is $148,600 ($500,000 sales price − $351,400 adjusted basis). You will report this transaction in 2024 because this is the year that the sale occurred. Your gain will be reported as you receive installment payments over the next five years, as follows: 2024: Realized gain of $148,600 reported; $0 gain recognized 2025-2029: $100,000  $148,600/$500,000 = $29,720 gain recognized

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You must also report interest income during 2025–2029.

Please let me know if you have any questions regarding this computation or anything else related to your 2024 tax return.

Sincerely, Carnes & Youngberg, CPAs Tax memo to the file Facts: Zian Davis sold one of his apartment buildings to Ace Arnold for $500,000 on October 31, 2024. Zian’s current adjusted basis as of the date of sale is $351,400. Zian will receive five annual payments of $100,000 each beginning January 1, 2025.

Issue: In which year must Zian report the realized gain (sale) on his tax return and when will the gain be taxed?

Conclusion: Zian will report the realized gain on the installment method on his 2024 tax return, and he will recognize the gain when the installment payments are received during 2025–2029.

Analysis: Under IRC §453(b)(1), the term installment sale means a disposition of property where at least one payment is to be received after the close of the taxable year in which the disposition occurs. Because Zian will receive five payments over a five-year period, the sale of his apartment building is an installment sale. Zian will calculate interest using a 6% interest rate with semiannual compounding and reported in each year beginning in 2025.

Realized gain = $148,600 ($500,000 sales price − $351,400 adjusted basis) 2024: Realized gain of $148,600 reported, $0 gain recognized 2025–2029: $100,000  $148,600/$500,000 = $29,720 gain recognized each year Time On Task: 15 minutes Ethics Problem 1) Title: Ethics Problem: Underreported Income Difficulty: Medium Learning Objective 1: 5.1 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 5.1 Solution: Although a tax practitioner can rely on his client’s records when preparing the tax return, under Statement on Standards for Tax Services No. 2.3.2, Reliance on Information from Others, a member "should not ignore the implications of information furnished and should make

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reasonable inquiries if the information furnished appears to be incorrect, incomplete, or inconsistent either on its face or on the basis of other facts known to the member." Also, Circular 230, §10.22 Diligence as to accuracy, states a practitioner must exercise due diligence in preparing or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to Internal Revenue Service matters. Because it is clear that Anthony is not reporting all the cash receipts and tips, you must inform him that under IRC §61(a) reportable income is from all sources, and he must report the cash receipts on his S corporation and the tips on his W-2 wages. If Anthony refuses to comply, the tax practitioner should disengage and not prepare his tax returns. The tax practitioner should inform Anthony of the liability, penalties, and interest that would be assessed by the Internal Revenue Service. The practitioner should also remember preparer penalties and the possible negative impact on their reputation and professional licensing if they prepare returns for a tax client where there is substantial understatement of income and where the practitioner as a professional had reasonable knowledge of the underreporting.

Time On Task: 10 minutes Excel Problem 1) Title: Excel Problem: Installment Sale Difficulty: Hard Learning Objective 1: 5.3 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 5.3 Solution: a.

Sales price $535,000 Less: Selling expenses (26,750) Amount realized $508,250 Less: Basis (395,000) Realized gain $113,250 Recognized gain reported each year = Payment received  Total gain/Contract price Year 23: $35,000  $113,250/$535,000 = $ 7,409 Year 24: $100,000  $113,250/$535,000 = 21,168 Year 25: $100,000  $113,250/$535,000 = 21,168 Year 26: $300,000  $113,250/$535,000 = 63,505 Total gain $113,250 b.

Sales price Less: Selling expenses Amount realized

$535,000 (26,750) $508,250

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Less: Basis Realized gain

(395,000) $113,250

Recognized gain reported each year = Payment received  Total gain/Contract price Year 23: $0  $113,250/$535,000 = $ Year 24: $225,000  $113,250/$535,000 = 47,629 Year 25: $ 75,000  $113,250/$535,000 = 15,876 Year 26: $235,000  $113,250/$535,000 = 49,745 Total gain $113,250

0

Input Area: Sale Proceeds Total Selling Expenses Basis in Land Proceeds Received in Year 23 Proceeds Received in Year 24 Proceeds Received in Year 25 Proceeds Received in Year 26

535,000 26,750 395,000 35,000 100,000 100,000 300,000

Calculation: Sales Price Less: Selling Expenses Amount Realized Less: Basis Realized Gain

$535,000 (26,750) $508,250 (395,000) $113,250

Recognized Gain Year 23 Recognized Gain Year 24 Recognized Gain Year 25 Recognized Gain Year 26 Total Recognized Gain

$ 7,409 21,168 21,168 63,505 $113,250

Input Area: Sale Proceeds Total Selling Expenses Basis in Land Proceeds Received in Year 23 Proceeds Received in Year 24 Proceeds Received in Year 25 Proceeds Received in Year 26

535,000 26,750 395,000 35,000 100,000 100,000 300,000

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Calculation: Sales Price Less: Selling Expenses Amount Realized Less: Basis Realized Gain

=+B4 =-B5 =B13+B14 =-B6 =B15+B16

Recognized Gain Year 23 Recognized Gain Year 24 Recognized Gain Year 25 Recognized Gain Year 26 Total Recognized Gain Time On Task: 15 minutes

=ROUND(B$17*B7/B$4,0) =ROUND(B$17*B8/B$4,0) =ROUND(B$17*B9/B$4,0) =ROUND(B$17*B10/B$4,0) =SUM(B19:B22)

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CPA Exam Preparation: Task-Based Simulations 1) Title: CPA Exam Preparation: Task-Based Simulation 1: Wisconsin Tool Company Difficulty: Medium Learning Objective 1: 5.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 5.3 Solution: Wisconsin Tool Company A

B Illini Die Co

C Spartan

D Hawkeye

a. Determine the realized gain/loss on the sale. b. Determine the Gross Profit Percentage.

Round to 2 decimal places. c. Determine the amount to be reported as income/loss in Year 23.

$150,000

($10,000)

$20,000

16.67%

0%

16.67%

$50,010

($10,000)

$20,000

a. Determine the realized gain/loss on the sale.

Illini

Spartan

Hawkeye

Cost Less: Accumulated Depreciation Adjusted basis

$750,000 0 $750,000

$500,000 (100,000) $400,000

$100,000 0 $100,000

Sales Price Less: Adjusted Basis Gain/Loss on sale

$900,000 (750,000) $150,000

$390,000 (400,000) ($10,000)

$120,000 (100,000) $ 20,000

Interest income is reported as ordinary income and is not part of the gain calculation.

An installment sale is a sale of property where one receives at least one payment after the tax year of the sale. The rules for installment sales do not apply if the taxpayer elects not to use the installment method or the transaction is one for which the installment method does not apply.

If a depreciation deduction was claimed or could have been claimed on property which is sold, the seller must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year. Section 1245 depreciation recapture is equal to the lesser of the realized gain on the sale or depreciation taken. The only asset sold that could

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potentially result in depreciation recapture is the sale of machinery to Spartan Construction Co. Because the sale resulted in a loss, no depreciation recapture applies. b. Determine the gross profit percentage.

The gross profit percentage is determined by taking the gross profit (realized gain) and dividing by contract price (amount realized less debt assumed by buyer less recapture recognized in year of sale).

Illini Spartan Hawkeye Gross profit percentage 16.67% 0% 16.67% ($150,000/$900,000) ($20,000/$120,000) c. Determine the amount to be reported as income/loss in Year 23.

Multiply the payment received each year by the gross profit percentage.

Illini Year 23: $300,000  16.67% (Rounded) = Year 24: $300,000  16.67% (Rounded) = Year 25: $300,000  16.66% (Rounded) = Total installment income

$50,010 50,010 49,980 $150,000

Spartan Year 23: ($10,000) Hawkeye Year 23: $20,000 The sale of inventory from WTI to Hawkeye does not qualify for installment sale treatment.

Taxpayers cannot use the installment method for property held for sale in the ordinary course of business (i.e. Inventory).

Interest income earned is not included in the gain from the sale.

Time On Task: 15 minutes 2) Title: CPA Exam Preparation: Task Based Simulation 2: Saenz—Qualified Business Income Difficulty: Hard Learning Objective 1: 5.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis

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Section Reference 1: 5.5 Solution: Saenz—Qualified Business Income

A a. Calculate the qualified business income deduction. $19,091 b. Calculate the qualified business income deduction if Stay Fit is an $0 athletic training business, the Saenzes are not partners or Scorporation shareholders in any businesses, and their taxable income before the QBI deduction is $485,000. c. Assume Stay Fit is not an athletic training business but rather a sports $5,211 retail store, and Stay Fit pays $5,000 in wages reducing QBI from Stay Fit to $29,800. Stay Fit has no qualified property. The Saenzes are not partners or S-corporation shareholders in any businesses.

Calculate the qualified business income deduction for Stay Fit if their taxable income before the QBI deduction is $394,700.

B

a. Calculate the qualified business income deduction.

The Qualified Business Income (QBI) deduction is allowed as a deduction from AGI. The deduction applies to taxpayers with QBI from a partnership, S corporation, or sole proprietorship. Generally, without any further limitations, a taxpayer may deduct 20% of the taxpayer’s QBI from a qualified trade or business (after application of the wage limit and after subtracting one half of the applicable self-employment tax generated) for each qualified trade or business.

A qualified trade or business is any trade or business other than a specified service trade or business and other than the trade or business of being an employee. A specified service trade or business is any trade or business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of an employee or owner.

Architecture and engineering services are specifically excluded from the definition of specified service trade or business. QBI does not include guaranteed payments.

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The wage/property limitation does not apply to the Saenzes because their modified taxable income does not exceed $383,900 (2024).

Electrolyte Partnership K-1: QBI Deduction Ordinary business income Net partnership income Self-employment tax rate Self-employment tax One half of SE tax Net QBI QBI deduction rate QBI deduction

$55,000  0.9235 $50,793  0.153 $ 7,771 $ 3,886 $51,114 ($55,000 – $3,886)  0.20 $10,223

BMI Inc. K-1: QBI deduction is $12,000 × 20% = $2,400.

Income generated from an S Corporation is not subject to self-employment tax.

Stay Fit Schedule C: QBI Deduction Schedule C income Net Schedule C income Self-employment tax rate Self-employment tax One half of SE tax

$34,800  0.9235 $32,138  0.153 $ 4,917 $ 2,459

Net QBI QBI deduction rate QBI deduction

$32,341 ($34,800 – $2,459)  0.20 $ 6,468

Once the QBI deduction is computed for each qualified business, the deductions are added together (businesses with losses have negative QBI) and the overall QBI deduction on the tax return is limited to 20% of the excess, if any, of taxable income over the taxpayer’s net capital gains (including qualified dividends) The Saenzes’ QBI deduction equals $19,091, the lesser of: a. $10,223 + $2,400 + $6,468 = $19,091, or b. 20% × (TI – Qualified Dividends) = 20% × ($275,000 – 500) = $54,900 b. Calculate the qualified business income deduction if Stay Fit is an athletic training business, the Saenzes are not partners or S-corporation shareholders in any businesses, and their taxable income before the QBI deduction is $485,000.

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If Stay Fit is an athletic training business, the business is considered a specified service trade or business.

For 2024, if the taxpayer’s modified taxable income (before the QBI deduction) is less than $191,950 ($383,900, MFJ), the exclusion for specified service trades or businesses will not apply. Therefore, a taxpayer operating a business that is a specified service trade or business still receives the QBI deduction if their modified taxable income does not exceed the thresholds. If the taxpayer has taxable income in excess of $191,950 ($383,900, MFJ), the exclusion phases in over a $50,000 range ($100,000, MFJ). The exclusion is fully phased in for taxpayers with taxable income in excess of $241,950 ($483,900, MFJ).

If the taxpayer has modified taxable income in excess of $241,950 ($483,900, MFJ) and is in a specified service trade or business, then no QBI deduction is allowed. Because the Saenzes’ modified taxable income is $485,000, their QBI deduction is $0. c. Assume Stay Fit is not an athletic training business but rather a sports retail store, and Stay Fit pays $5,000 in wages, reducing QBI from Stay Fit to $29,800. Stay Fit has no qualified property. The Saenzes are not partners or S-corporation shareholders in any businesses. Calculate the qualified business income deduction for Stay Fit if their taxable income before the QBI deduction is $394,700.

1. First, calculate the QBI deduction without the wage limitation: Schedule C income Net Schedule C income Self-employment tax rate Self-employment tax One half of SE tax

$29,800  0.9235 $27,520  0.153 $ 4,211 $ 2,106

Net QBI QBI deduction rate QBI deduction

$27,694 ($29,800 – $2,106)  0.20 $ 5,539

2. Then, calculate the reduction ratio, which is the amount of taxable income in excess of the threshold divided by the $100,000 range. $394,700 – $383,900 = $10,800 ÷ $100,000 = 10.8% 3. Next, calculate the excess amount, which is the QBI deduction before the wage/property limitation less the QBI deduction with a fully phased-in wage and property limitation.

Wage/Property limitation is $2,500, the greater of: a. 50% of the wages paid with respect to the qualified trade or business = $2,500 ($5,000 × 50%), or

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b. The sum of 25% of the wages with respect to the qualified trade or business plus 2.5% of the unadjusted basis for all qualified property in the qualified trade or businesses = (25% × $5,000 + (2.5% × $0) = $1,250.

Therefore, the excess amount = $3,039 ($5,539 – $2,500).

4. Multiply the excess amount by the reduction ratio: $3,039 × 10.8% = $328 5. Finally, calculate the QBI deduction after phase-outs: $5,539 – $328 = $5,211 Time On Task: 20 minutes

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Chapter 6—Income from Personal Activities End-of-Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Easy Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: If Art is not a professional gambler, he must report his winnings of $5,000 on his tax return.

We'll see in Chapter 9, LO8, Other Itemized Deductions, that if Art itemizes his deductions, he may take his gambling losses to the extent of his gambling winnings as a deduction on Schedule A. Time on Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Easy Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: Stacy must report $500,000 in her taxable income as income from a prize or award.

Time on Task: 1 minute 3) Title: Discussion Question 3 Difficulty: Medium Learning Objective 1: 6.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.1 Solution: Chung may have to report the value of the Nobel Peace Prize. Most awards are taxable income.

An individual can exclude the value of prizes or awards if they are for civic, artistic, educational, scientific, or literary achievement and the recipient: 1. Is selected without action on their part;

2. Is not required to perform services; and 3. Does not accept the award and the organization granting the award sends it directly to a tax-exempt or governmental organization.

Time on Task: 3 minutes 4) Title: Discussion Question 4 Difficulty: Easy Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: Terry must report $19,000 in his taxable income from the scholarship. Only scholarship awards covering tuition, fees, books, and equipment qualify for the exclusion from gross income.

Time on Task: 2 minutes 5) Title: Discussion Question 5 Difficulty: Medium Learning Objective 1: 6.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.2 Solution: Alimony is a court-ordered provision for a former spouse after a divorce. Child support payments are court-ordered payments, typically made by a noncustodial divorced parent, to support one's minor child or children. For divorces finalized prior to January 1, 2019, alimony is deductible by the payor and includible in income by the recipient. For divorces finalized after December 31, 2018, alimony is not deductible by the payor and not includible in income by the recipient. To qualify as alimony, the payments must be: a. Required by decree or written agreement and not characterized as something other than alimony; b. Made in cash; c. Paid to or on behalf of the former spouse; d. Set to terminate upon death of recipient; and e. Payor and payee cannot be members of the same household.

Time on Task: 4 minutes 6) Title: Discussion Question 6 Difficulty: Easy Learning Objective 1: 6.2

Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.2 Solution: Shan does not have to include any of the items in taxable income. Transfers of property to a former spouse under a divorce decree are not a taxable event.

Time on Task: 2 minutes 7) Title: Discussion Question 7 Difficulty: Easy Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: The $100,000 gift received is not taxable to Tashi for income tax purposes. Cash gifts are not includible in income of the recipient. Tashi’s aunt may need to pay gift tax on the gift.

Time on Task: 2 minutes 8) Title: Discussion Question 8 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.3 Solution: The receipt of the home is not taxable income to Tabitha. This is an inheritance which is specifically excluded upon receipt. When Tabitha sells the home, she will have a recognized transaction and she must report the potential gain on her tax return.

Time on Task: 2 minutes 9) Title: Discussion Question 9 Difficulty: Easy Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution:

No, the value of the ham is not taxable to Aki because the value does not exceed $25 and is not paid in cash.

Time on Task: 1 minute 10) Title: Discussion Question 10 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.3 Solution: The gain basis is the adjusted basis of the donor. The loss basis is the lower of the fair market value at the date of the gift or adjusted basis of the donor. The depreciable basis is equal to the gain basis.

Time on Task: 2 minutes 11) Title: Discussion Question 11 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.3 Solution: Typically, the fair market value at the date of death is used to determine the beneficiary’s basis in the asset inherited. The alternate valuation date (AVD, six months after the date of death) is used if the executor of the estate elects to use it. The executor can elect the AVD only if the value of the estate is less on the AVD and it reduces the amount of estate tax that has to be paid.

Time on Task: 3 minutes 12) Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 6.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.4 Solution: Jahleel must report both the damage award of $50,000 and the punitive damages of $100,000 in taxable income. Slander is a non-physical injury, and the resulting receipt of payments are includible.

Time on Task: 3 minutes

13) Title: Discussion Question 13 Difficulty: Easy Learning Objective 1: 6.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.5 Solution: The life insurance proceeds of $1,000,000 are not taxable to Karen. Life insurance proceeds are specifically excluded from gross income of the recipient.

Time on Task: 2 minutes 14) Title: Discussion Question 14 Difficulty: Medium Learning Objective 1: 6.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.6 Solution: If Spartan Credit Union forgives the loan of $2,200, Morgan must report this on her tax return.

Forgiveness of debt is considered income unless a specific exception exists.

Time on Task: 2 minutes 15) Title: Discussion Question 15 Difficulty: Medium Learning Objective 1: 6.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.7 Solution: Income in respect of a decedent (IRD) is income that was owed to a decedent at the time they died. Examples of IRD include retirement plan distributions, IRA distributions, unpaid interest and dividends, salary, wages, and sales commissions, to name only a few.

Time on Task: 2 minutes 16) Title: Discussion Question 16 Difficulty: Medium Learning Objective 1: 6.7 Standard 1: AACSB || Knowledge

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.7 Solution: A parsonage allowance is given to a clergy member or rabbi as a housing allowance. The clergy member or rabbi can live in housing provided by the charitable organization or be provided monthly income towards the rental for living arrangements. The clergy or rabbi can exclude the rental value of the parsonage or the cash rental allowance for a parsonage from income. They can also exclude amounts received to pay utilities on the property.

Time on Task: 3 minutes Multiple Choice Questions 1) Answer: a Title: Multiple Choice Question 1 Difficulty: Medium Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: The correct answer is Prize of $1,000 won at the VFW Bingo game.

A prize won from a VFW bingo game is taxable income. Medals won at the Olympics are excluded from income, therefore the Olympic bronze medal is excludable from income. The scholarship received that covers tuition and fees is also excludable. The turkey valued at $20 given by an employer is considered de minimis and not included in income.

Time on Task: 4 minutes 2) Answer: d Title: Multiple Choice Question 2 Difficulty: Medium Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: The correct answer is All of these are considered taxable income.

Winnings from the racetrack, raffle ticket, and Nobel Peace Prize are all taxable income. The Nobel Peace Prize can only be excluded from income if certain conditions are met.

Time on Task: 4 minutes 3)

Answer: b Title: Multiple Choice Question 3 Difficulty: Medium Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: The correct answer is $14,000.

Room and board of $14,000 is includible in income. A scholarship awarded to cover tuition, fees, books, and equipment is excluded from income.

Time on Task: 3 minutes 4) Answer: c Title: Multiple Choice Question 4 Difficulty: Medium Learning Objective 1: 6.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.2 Solution: The correct answer is Alimony received before January 1, 2019.

Alimony received before January 1, 2019 is taxable income to the recipient. Child support is never includible. Alimony received in a divorce decree settled after December 31, 2018 is not includible in taxable income.

Time on Task: 2 minutes 5) Answer: b Title: Multiple Choice Question 5 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: The correct answer is I & II only.

The gift received from Desiree’s employer is considered for work performed and taxable. The gift received from her friend for styling hair is also for work performed and taxable. The gift from her mom is excludable.

Time on Task: 4 minutes

6) Answer: d Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: The correct answer is $3,000.

Gain basis is equal to the donor’s basis of $1,500. Jamal sold the stock for $4,500 which is more than the gain basis of $1,500, so his gain is $3,000.

Time on Task: 3 minutes 7) Answer: c Title: Multiple Choice Question 7 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: The correct answer is Gain basis $17,000, Loss basis $12,000.

Gain basis is equal to the donor’s basis of $17,000. Loss basis is $12,000, the lower of gain basis, $17,000, or fair market value, $12,000.

Time on Task: 3 minutes 8) Answer: b Title: Multiple Choice Question 8 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: The correct answer is $460,000.

The alternate valuation date (AVD) is six months after the date of death and is used if properly elected by the executor if the property is distributed after the AVD. Time on Task: 4 minutes 9)

Answer: c Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: The correct answer is $2,000.

Depreciable basis is equal to the loss basis which is the lower of cost or fair market value on the date of conversion.

Time on Task: 3 minutes 10) Answer: d Title: Multiple Choice Question 10 Difficulty: Medium Learning Objective 1: 6.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.4 Solution: The correct answer is All of these.

All of the choices are considered taxable income.

Time on Task: 2 minutes 11) Answer: b Title: Multiple Choice Question 11 Difficulty: Medium Learning Objective 1: 6.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.5 Solution: The correct answer is $45,000.

Individual retirement accounts received as an inheritance are considered taxable income to the recipient when money is withdrawn from the account. The other items received are excludable as inheritance.

Time on Task: 3 minutes 12) Answer: c

Title: Multiple Choice Question 12 Difficulty: Medium Learning Objective 1: 6.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.6 Solution: The correct answer is Debt forgiven of $300,000 by bank on the mortgage of your principal residence.

Debt forgiveness is typically considered income. However, debt forgiveness on a principal residence not exceeding $750,000 is excludable from income.

Time on Task: 3 minutes 13) Answer: d Title: Multiple Choice Question 13 Difficulty: Medium Learning Objective 1: 6.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 6.7 Solution: The correct answer is All of these are considered income in respect of a decedent.

All items are considered income in respect of a decedent.

Time on Task: 3 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Easy Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: The Jackson family must report both the cash of $21,370 and the value of the Jeep at $32,500.

Prizes and awards won at a gameshow are taxable income because there is no exclusion in the code for prizes and awards.

Time on Task: 3 minutes 2) Title: Brief Exercise 2

Difficulty: Medium Learning Objective 1: 6.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.2 Solution: Shreya can exclude the $48,000 of child support received. She can also exclude the $120,000 value of the home. Because the payments for alimony were not paid in cash, the $120,000 home can be excluded from Shreya’s income.

Time on Task: 4 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: Loris’s gain basis is equal to the donor’s adjusted basis, $8,300. Her loss basis is equal to the lesser of gain basis ($8,300) or fair market value ($11,000). Loris’s loss basis is $8,300.

Time on Task: 4 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: Shelby’s basis in the land inherited is equal to the fair market value as of the date of death (August 15), assuming that the executor has not elected the alternate valuation date. Shelby’s basis in the land is $82,000.

Time on Task: 4 minutes 5) Title: Brief Exercise 5 Difficulty: Medium Learning Objective 1: 6.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application

Section Reference 1: 6.4 Solution: Garret must include in income the punitive damages of $400,000. The damage award is excludable because it is due to a physical injury. He cannot take a deduction for the attorney fee of $250,000. Only attorney fees related to discrimination are deductible.

Time on Task: 4 minutes 6) Title: Brief Exercise 6 Difficulty: Medium Learning Objective 1: 6.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.5 Solution: Taxpayers can exclude from income proceeds of life insurance received due to the death of the insured; however, employee death benefits are included as income in the employee's wages for the year as the payments are paid only because the individual rendered services to the employer.

The $50,000 received for employee death benefits is taxable.

Time on Task: 4 minutes 7) Title: Brief Exercise 7 Difficulty: Medium Learning Objective 1: 6.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.6 Solution: Because this is real property in a trade or business, Francesco has no income from the forgiveness of debt, but he must reduce the basis of the warehouse by $25,000. The new basis is $20,000 ($45,000 − $25,000).

Time on Task: 4 minutes 8) Title: Brief Exercise 8 Difficulty: Medium Learning Objective 1: 6.1, 3, 7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1, 3, 7 Solution:

Todd must report the unemployment compensation of $12,000, lottery winnings of $1,000, and the gambling winnings of $4,000. He can exclude the food stamps which is considered a welfare payment and the gift from his grandma. Todd must include $17,000 in taxable income.

Time on Task: 4 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Easy Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: Yes, Delilah must include all the prizes won in income.

Time on Task: 3 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: Yes, Fran must report the value of the cash and jewelry in income under the treasure trove principle ($100 + $2,000 = $2,100). Fran has a basis of $25 in the nightstand and $45 in the armoire.

Time on Task: 3 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: Sven does not include the $2,000,000 in his taxable income. Awards and prizes are typically includible, but an exception exists if the award is for civic, artistic, educational, scientific, or literary achievement, and the recipient:

1. Is selected without action on their part; 2. Is not required to perform services; and 3. Does not accept the award and the organization granting the award sends it directly to a tax-exempt or governmental organization.

Time on Task: 4 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: Elijah must report $11,500 as income for the room and board. Elijah can exclude only scholarship dollars received for tuition, fees, books, and supplies and equipment from income.

Time on Task: 4 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 6.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1 Solution: Sylvane must report $18,000 as other income on his tax return. (The gambling expenses are discussed in detail in Chapter 9, LO8, Other Itemized Deductions. Only $18,000 is deductible because the gambling loss is limited to the amount of gambling income.)

Time on Task: 4 minutes 6) Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 6.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.2 Solution: a. Because the divorce was finalized prior to January 1, 2019, Donny must include the alimony payments of $60,000 in income. The child support payments are excludable.

Also, the property settlements from the divorce are excludable as well.

b. Because the divorce was finalized in 2019, Donny does not have to report any payments in income, as alimony is no longer taxable if the divorce was finalized after December 31, 2018. The property settlements from the divorce are also excludable.

Time on Task: 4 minutes 7) Title: Application Problem 7 Difficulty: Hard Learning Objective 1: 6.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.2 Solution: If the payor does not remit the required amount of child support and alimony, the tax law requires the payments to first be allocated to child support. The $60,000 Steve paid is allocated first to $24,000 of child support. Leslie must include the remaining $36,000 in her income and Steve may deduct $36,000 as an alimony payment.

Time on Task: 5 minutes 8) Title: Application Problem 8 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: Of the items discussed, only Michael and Miriam’s share of the IRA that was distributed to them is taxable income. The other items received as an inheritance are excludable. The life insurance proceeds are excluded because they were paid due to the death of the insured.

Time on Task: 8 minutes 9) Title: Application Problem 9 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: Ichiro must report a $3,300 ($5,500 − $2,200) gain from the sale of the stock. He receives the same basis as his uncle’s basis in the gift for purposes of calculating gain on the sale.

Time on task: 3 minutes

10) Title: Application Problem 10 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: Shaquille's gain basis is equal to the donor’s basis of $5,000. Loss basis is $5,000, the lower of gain basis of $5,000 or fair market value of $8,500.

Time on Task: 4 minutes 11) Title: Application Problem 11 Difficulty: Hard Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: The adjustment to basis for gift tax paid is: Gift tax paid ($10,000) ×

(FMV [$400,000] − Adjusted basis [$250,000) = $3,927 FMV [$400,000] − $18,000

Jerome's gain basis is equal to the donor’s basis of $250,000 + $3,927 =$253,927 Loss basis is equal to the lower of gain basis of $250,000 or fair market value of $400,000, plus $3,927 ($250,000 + $3,927 = $253,927).

Time on Task: 8 minutes 12) Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: Timiri's gain basis is equal to the donor’s basis of $6,250.

Loss basis is $5,000, the lower of gain basis $6,250 or fair market value of $5,000.

a.

If Timiri sells it for $7,700: Amount realized $7,700 Gain basis (6,250) Recognized gain $1,450

b.

If Timiri sells it for $4,0300: Amount realized $4,300 Loss basis (5,000) Realized loss $ 700 Loss is not recognized if the ring is a personal use asset. (See Chapter 15)

c.

If Timiri sells it for $5,500:

Neither gain nor loss occurs because it is sold for an amount in between the gain basis and loss basis.

Time on Task: 8 minutes 13) Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: a. If Terry sells it for $8,000: Amount realized $8,000 Gain basis (5,750) Recognized gain $2,250 Terry’s holding period includes the donor’s three-year holding period since Terry sold the asset at a gain. b. If Terry sells it for $4,000: Amount realized $4,000 Loss basis (4,500) Recognized loss $ 500 Loss is not recognized if the necklace is a personal use asset. (See Chapter 15).

If Terry sold the asset at a loss, the holding period begins the day after the date received, which is December 26. c. If Terry sells it for $5,300:

Neither gain nor loss occurs because it is sold for an amount in between the gain basis and loss basis. The holding period is irrelevant if there is no gain or loss recognized.

Time on Task: 8 minutes 14) Title: Application Problem 14 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: The grandson’s basis in the home is the value as of the date of death, $400,000. The holding period is always long-term for an inheritance.

Time on Task: 4 minutes 15) Title: Application Problem 15 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: The executor of the estate properly elected to value the property on the alternate valuation date of August 22, Year 7. The Florida home was distributed on July 19, which is before the alternate valuation date, so the home’s basis is the value on the distribution date of $420,000. The executor distributed the South Carolina home after the alternate valuation date, so the value of $515,000 on the alternate valuation date is used. The holding period is long-term for an inheritance.

Time on Task: 8 minutes 16) Title: Application Problem 16 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: Mitch's gain basis is the adjusted basis of the property, $1,500.

The loss basis, $700, is the lower of:

Fair market value (FMV) at the date converted ($700), or Adjusted basis of the property ($1,500) The depreciable basis is equal to the loss basis, $700.

Time on Task: 4 minutes 17) Title: Application Problem 17 Difficulty: Hard Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.3 Solution: The fair market value basis rule is not applicable to appreciated property acquired by the decedent by gift within one year before death if such property then passes from the doneedecedent to the original donor or donor's spouse. The basis of such property to the original donor (or spouse) will be the adjusted basis of the property to the decedent immediately before death, $22,000.

Time on Task: 8 minutes 18) Title: Application Problem 18 Difficulty: Medium Learning Objective 1: 6.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.4 Solution: Haruo must report the settlement from a breach of contract of $25,000. Workers’ compensation and amounts received from being wrongfully incarcerated are excluded from income.

Time on Task: 4 minutes 19) Title: Application Problem 19 Difficulty: Medium Learning Objective 1: 6.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.4 Solution: Devon must report the punitive damages of $750,000 as income. Because the settlement for compensatory damages and the medical reimbursement are from a physical injury, they may be

excluded from income. In addition, the medical expenses were not deducted by Devon and, therefore, none of the reimbursement of the medical expenses is included in income.

Time on Task: 4 minutes 20) Title: Application Problem 20 Difficulty: Medium Learning Objective 1: 6.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.4 Solution: Devon must report the punitive damages of $750,000 as income. Because the settlement for compensatory damages is from a physical injury, it may be excluded from income. The medical expense payment of $12,000 must be included in income to the extent of the benefit of the deduction received (per the tax benefit rule), or $9,000.

Time on Task: 5 minutes 21) Title: Application Problem 21 Difficulty: Medium Learning Objective 1: 6.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.4 Solution: Sylvia must report the $1,000,000 sexual discrimination settlement, but she also can deduct the legal fees of $300,000 as a deduction for AGI. Time on Task: 4 minutes 22) Title: Application Problem 22 Difficulty: Medium Learning Objective 1: 6.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.5 Solution: Basma can exclude the $50,000 received from her life insurance policy from her income.

Because she is chronically ill, Basma can exclude the proceeds from income only to the extent she uses it to pay for her long-term care.

Time on Task: 4 minutes

23) Title: Application Problem 23 Difficulty: Medium Learning Objective 1: 6.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.5 Solution: Jade must include a portion of the monthly payment in income.

The allocated cost to each payment is $1,667 [$600,000/ 30 years / 12 months] The $333 ($2,000 − $1,667) received each month in excess of the $1,667 basis is interest income. Because her payments began in August, Jade must include $1,665 in income in the current year ($333  5 months).

Time on Task: 6 minutes 24) Title: Application Problem 24 Difficulty: Medium Learning Objective 1: 6.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.6 Solution: Raelyn must report as income the credit card debt forgiven of $14,000 and the auto loan forgiven of $19,500. The loan forgiven by her brother of $8,000 is because of love or generosity and considered a gift by her brother. The debt forgiven of $155,000 from her principal residence is excludable although Raelyn must reduce the basis in her principal residence by the amount of debt forgiven. Raelyn must include $33,500 in her taxable income.

Time on Task: 5 minutes 25) Title: Application Problem 25 Difficulty: Hard Learning Objective 1: 6.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.6 Solution: a. Jeff does not have to include the forgiveness of debt in his income, but he does have to reduce his tax attributes to the extent of the debt forgiven.

Reduction Balance NOL for the current year $45,000 $45,000 $0

NOL from the previous year Capital loss carryforward Adjusted basis of his business property

$22,000 $ 4,500 $68,000

$22,000 $ 4,500 $28,500

$0 $0 $39,500

b. Jeff does not have to include the forgiveness of debt in his income, but he does have to reduce his tax attributes to the extent of the debt forgiven. Jeff will apply the $100,000 reduction to the basis of the depreciable property first and then reduce the other attributes.

Adjusted basis of his business property NOL for the current year NOL from the previous year Capital loss carryforward Time on Task: 8 minutes

$68,000 $45,000 $22,000 $ 4,500

Reduction $68,000 $32,000 $ 0 $ 0

Balance $ 0 $13,000 $22,000 $ 4,500

26) Title: Application Problem 26 Difficulty: Hard Learning Objective 1: 6.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.6 Solution: Jackie’s insolvency is $140,000 ($125,000 assets less $265,000 debts). Therefore, $140,000 of the debt forgiveness can be excluded from income but will require tax attributes to be reduced.

Jackie must include the remaining $60,000 of debt forgiveness in income. $200,000 Debt Forgiveness

$140,000 Insolvency Excluded from Income Tax Attributes Reduced Time on Task: 8 minutes 27) Title: Application Problem 27 Difficulty: Medium Learning Objective 1: 6.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.6 Solution:

$60,000 Forgiveness Included in Income

Nicki must include $81,200 ($6,200 + $75,000) in her taxable income. The cancelation of credit card debt is forgiveness of debt, and she must include it in income as well as Lewis’s last paycheck and bonus. The life insurance proceeds and gift from her mom are excludable. The forgiveness of student loan debt due to death or disability is also excludable.

Time on Task: 8 minutes 28) Title: Application Problem 28 Difficulty: Medium Learning Objective 1: 6.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.6 Solution: Tristan and Tiffany must report the unemployment compensation of $12,000 in taxable income.

The forgiveness of debt on a principal residence is excludable in 2024 up to $750,000. Because the couple’s forgiveness of debt was $2,200,000, Tristan and Tiffany must report $1,450,000 ($2,200,000 − $750,000) of forgiveness of debt in their taxable income.

Time on Task: 6 minutes 29) Title: Application Problem 29 Difficulty: Medium Learning Objective 1: 6.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.7 Solution: a. Juan must report $375 ($75  5) of jury duty pay on his tax return. b. Juan must report the $375 ($75  5) of jury duty pay on his tax return and he can also take a deduction for AGI of $375 if he must remit the pay to his employer.

Time on Task: 6 minutes 30) Title: Application Problem 30 Difficulty: Medium Learning Objective 1: 6.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.7 Solution:

Liam must report the $250 of jury duty pay, $6,500 of unemployment compensation, and $200 cash found. He does not have to report the $4,800 of Temporary Assistance for Needy Families payments nor the $2,000 gift received. Total income to be reported is $6,950.

Time on Task: 6 minutes 31) Title: Application Problem 31 Difficulty: Medium Learning Objective 1: 6.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.7 Solution: Rabbi Solomon must report the wages of $60,000. He may exclude the housing allowance of $12,000 and the utilities reimbursement of $6,000 as a parsonage allowance. Because the actual utilities cost exceeded the allowance, none of the $6,000 allowance for utilities is included in Rabbi Solomon’s income.

Time on Task: 5 minutes 32) Title: Application Problem 32 Difficulty: Hard Learning Objective 1: 6.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.7 Solution: These items are income in respect of a decedent. The accrued interest of $1,000 and the wages of $2,850 are taxed to Russell's estate as ordinary income when it files its income tax return. The $3,600 is taxed as rental income to his nephew who received the rental income. The $800 is taxed as dividend income to his son because the record date was before the date of death and his son received the dividend income.

Time on Task: 8 minutes 33) Title: Application Problem 33 Difficulty: Medium Learning Objective 1: 6.1, 3, 7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 6.1, 3, 7 Solution:

Scarlett must report the $1,000 for tennis lessons given to a friend as this is earned income. She must include the unemployment compensation of $12,000 and the lottery winnings of $50,000 in income. The gift of $20,000 and the inheritance of $100,000 are excluded from income. Scarlett must include $63,000 in income ($1,000 + $12,000 + $50,000).

Time on Task: 6 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 6.3 Solution: Stock Coca-Cola Costco Sears

Cost $4,400 $1,500 $4,000

Fair market value $5,000 $3,000 $ 100

Unrecognized gain/loss $ 600 $ 1,500 ($3,900)

Herbert should not gift property that has an unrecognized loss in it because the loss will disappear. He should sell the Sears stock so that he can recognize the loss and then gift the sales proceeds. Depending on his age and health, Herbert should consider holding off on gifting the stock with a gain. If Herbert bequeaths the gain stock to his nephew after his death, the nephew will have a stepped-up basis (FMV at date of death) and recognize and pay tax on less gain, but receive the full value of the stock.

Time on Task: 8 minutes 2) Title: Tax Planning Problem 2 Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 6.3 Solution:

Asset Walmart stock Personal residence Honda Accord

Cost $10,000 $69,000 $25,000

Fair market value $ 22,000 $325,000 $ 12,000

Unrecognized gain/loss $ 12,000 $256,000 ($ 13,000)

Myrtle should bequeath the Walmart stock and personal residence to her children and grandchildren in her will. The beneficiaries will receive a stepped-up basis (FMV at date of death) as their basis for the Walmart stock and personal residence. When they sell the assets, they will report less gain and pay less tax because they have a higher basis. The Honda Accord is a personal use asset and if sold by Myrtle, she would have a nondeductible loss of $13,000. If she gifts the property, the loss will disappear but that is acceptable because the loss is nondeductible anyway.

Time on Task: 8 minutes Communication Problems 1) Title: Communication Problem 1: Determining Reportable Income Items Difficulty: Medium Learning Objective 1: 6.1, 3, 7 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 6.1, 3, 7 Solution: Memo to Client Hello Eugenia, It was good to meet you the other day to discuss your tax situation for 2024. The Internal Revenue Code states that all income recognized is includible in gross income unless an exclusion applies. For the items that we discussed, the following are taxable.

• • •

Unemployment compensation $28,000 Bingo winnings $2,000 Discovery of cash $1,000

All these items are taxable on your tax return. Congress has provided exclusions from income for the gift of $10,000 and inheritance of $25,000 so these do not have to be reported at all.

Please let me know if you have any questions about these income items or anything else affecting your tax return. It is a pleasure to serve you.

Sincerely, Carnes & Youngberg, CPAs Tax memo to the file Facts: Eugenia received the following in 2024.

• • • • •

Unemployment compensation $28,000 Bingo winnings $2,000 Gift of $10,000 Inheritance of $25,000 Discovery of cash $1,000

Issue: How much of the income must Eugenia include in taxable income?

Conclusion: Eugenia must include the unemployment compensation, bingo winnings, and the discovery of cash in income. The gift received and the inheritance received are excludable from taxable income.

Analysis: Internal Revenue Code §61(a) states that gross income is from whatever source derived. To exclude an income item, a code section must support it. Gifts and inheritances received are excluded under IRC §102(a).

Time on Task: 15 minutes 2) Title: Communication Problem 2: Sale of Inherited Property Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 6.3 Solution: Hello Dee, I enjoyed our dinner a few weeks ago and am writing to continue our discussion regarding the stock inheritance you received from your late aunt. You are correct that you can exclude the value of an inheritance from your taxable income. However, the sale of the stock is a property transaction, and you must compute your gain or loss from the sale. Your basis in the stock is $17,000, the fair market value as of your aunt’s date of death. Your gain is $8,000 ($25,000 amount realized − $17,000 adjusted basis). Stock is an investment, so the gain is a capital gain.

The good news is that the tax law treats inherited property as if held long term, so the $8,000 is a long-term capital gain and thus is taxed at preferential rates.

Please let me know if you have any further questions.

Thank you, Carnes & Youngberg, CPAs Time on Task: 8 minutes Ethics Problem

1) Title: Ethics Problem: Divorce Advice Difficulty: Medium Learning Objective 1: 6.2 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 6.2 Solution: According to Statement on Standards for Tax Services No. 3.1.2, Standards for Members Providing Tax Consulting Services, states that a member "should use professional judgement to ensure that tax advice provided in a tax consulting engagement is competent and based on applicable standards." Susan should use her professional judgment to ensure that tax advice provided to the taxpayers reflect competence and appropriately serves the taxpayer’s needs.

Circular 230, §10.29a Conflicting Interests provides that “a practitioner shall not represent a client before the Internal Revenue Service if the representation involves a conflict of interest. A conflict of interest exists if—(1) The representation of one client will be directly adverse to another client…” However, in §10.29b, “the practitioner may represent a client if—(1) The practitioner reasonably believes that the practitioner will be able to provide competent and diligent representation to each affected client; (2) The representation is not prohibited by law; and (3) Each affected client waives the conflict of interest and gives informed consent, confirmed in writing by each affected client, at the time the existence of the conflict of interest is known by the practitioner…”

Based on the information provided, Susan may prepare both clients’ tax returns if both Kevin and Pam agree. However, if she is to provide the best tax advice as it relates to alimony, it would be best for her to separate herself from either Kevin or Pam. Kevin wants the divorce in 2018 in which case he would be able to take an alimony payment deduction on his tax return and Pam must report the alimony received on her tax return for 2018 and all future years. Pam, on the other hand, wants the divorce finalized in 2019 so the alimony payment would not be includible in her income, and it would not be deductible on Kevin’s tax return. Susan can provide this information to both Kevin and Pam, but the divorce attorneys will need to structure the divorce decree accordingly for their clients.

Time on Task: 8 minutes Research Problem 1) Title: Research Problem 1: Gifting of Assets to Terminally Ill Relative Difficulty: Hard Learning Objective 1: 6.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 6.3 Solution:

You will achieve the stepped-up basis only if your grandfather lives for at least one year from the date of the gift. IRC §1014(e) prohibits a step-up in basis in regard to appreciated property that was acquired by the decedent via a gift within one year of their death. Thus, section 1014(e) provides for a carryover basis for such property; that is, your basis will be the same basis your grandfather had in the asset and his beginning basis for the gifted property was your basis on the date of gift. You will achieve the desired result and receive the stepped-up basis if your grandfather lives for at least 12 months after the date of the gift. If he dies only 11 months after the date of the gift, your basis will be your original basis (carryover basis).

Time on Task: 10 minutes Excel Problems 1) Title: Excel Problem 1: Basis of Property Received through Inheritance Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 6.3 Solution:

Input Area:

Date

FMV

Decedent basis in property

85,000

14 January 535,000

FMV on date of death - January 14

535,000

31 March 522,000

FMV on date of distribution - March 31

522,000

14 July 515,000

FMV on alternate valuation date - July 14

515,000

Calculation: Date used for valuation

14 July

Beneficiary's basis in property

515,000

Calculation: Date used for valuation Beneficiary's basis in property

7/14/20XX =VLOOKUP(B12,D6:E8,2,FALSE)

a. Magdalena’s basis in the cottage is equal to the fair market value as of the date of death, or $535,000. b. The general rule states that the fair market value at the date of death is the basis for all assets included in the gross estate. An exception exists if the executor elects to value the

property on the alternate valuation date (AVD), which is 6 months after the date of death.

In that case, the basis is the value on the AVD. However, if the executor elects the alternate valuation date, but an asset is distributed in between the date of death and the alternate valuation date, then the fair market value as of the date of distribution is the basis in the asset. Because the executor distributed the asset two and one-half months after the date of death, the basis in the cottage is $522,000 which is the value as of the date of distribution.

Time on Task: 15 minutes 2) Title: Excel Problem 2: Basis of Property Received as a Gift Difficulty: Medium Learning Objective 1: 6.3 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 6.3 Solution:

Input Area: Donor's basis in stock FMV on date of gift Sale price of stock

4,500 8,800 10,200

Calculation: Gain Basis Loss Basis

=+B19 =MIN(B19,B20)

Amount realized

=+B21 =IF(B27>B24,B24,IF(B27<B25,B25,B27) ) =+B27-B28

Less: Adjusted basis Recognized gain (loss)

a. Porter’s recognized gain is $5,700: Amount realized $10,200 Less: Adjusted basis ( 4,500) Recognized gain $ 5,700 Because Porter sold the stock for above the gain basis ($4,500), which is the donor’s adjusted basis, Porter will use $4,500 as his basis. b. Porter’s recognized loss is $400: Amount realized

$4,100

Less: Adjusted basis (4,500) Recognized loss ($ 400) Because Porter sold the stock below loss basis which is the lesser of gain basis ($4,500) or fair market value ($8,800), Porter will use $4,500 as his basis. c. Porter’s recognized gain is $2,100: Amount realized $6,600 Less: Adjusted basis (4,500) Recognized gain $2,100 Because Porter sold the stock for more than the gain basis ($4,500), which is the donor’s adjusted basis, Porter will use $4,500 as his basis to compute a gain of $2,100. d. Porter’s recognized gain or loss is $0.

Amount realized Adjusted basis Recognized gain

$4,200 ( 4,200) $ 0

Because Porter sold the stock for an amount in between the gain basis ($4,500) and loss basis ($4,000), no gain or loss is recognized.

Time on Task: 15 minutes CPA Exam Preparation: Task Based Simulations 1) Title: CPA Exam Preparation: Task Based Simulation: Review of Documents to Determine Inclusion Difficulty: Medium Learning Objective 1: 6.1, 6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 6.1, 6 Solution: 1. What must Sumner report as income from his 1098-T? 2. What must Sumner report as income from his 1099-C? 3. What must Sumner report as income from his W-2G? Rationale

$3,600 $2,000 $5,000

1. Eligible school expenses that Sumner may use to offset the scholarship received include qualified tuition and fees, books, supplies and equipment. His total eligible school expenses are $21,400 ($20,500 + $500 + $400). Sumner must include any scholarship received that is in excess of eligible educational expenses. His includible income is $3,600 ($25,000 − $21,400).

2. Sumner must include the $2,000 from cancelation of debt in income.

3. Sumner must include the $5,000 bingo winnings from his church in income.

Time on Task: 12 minutes 2) Title: CPA Exam Preparation: Task Based Simulation: Items Included in Income Difficulty: Medium Learning Objective 1: 6.1, 3, 5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 6.1, 3, 5 Solution: 1. Dale received a $30,000 cash gift from her aunt.

0

2. The Cumacks received a $1,000 federal income tax refund.

0

3. Frank received $10,000 as beneficiary of his deceased brother's life insurance policy.

0

4. Frank won $5,000 at a casino and had $2,000 in gambling losses.

5,000

5. The Cumacks received $1,000 interest income associated with a refund of their prior year's federal income tax.

1,000

6. Zeno Corp. declared a stock dividend and Dale received 0 one additional share of Zeno common stock for three shares of Zeno common stock that she held. The stock that Dale received had a fair market value of $9,000. There was no provision to receive cash instead of stock.

Rationale You Answered Correctly!

Rationale: 1. ($0) Amounts received as a gift are fully excluded from gross income.

2. ($0) Because federal income taxes are not deductible in computing a taxpayer's federal income tax liability, a refund of federal income taxes is excluded from gross income.

3. ($0) The proceeds of life insurance policies paid by reason of death of the insured are generally excluded from the beneficiary's gross income.

4. ($5,000) Gambling winnings must be included in gross income. Gambling losses cannot be offset against gambling winnings, but instead are deducted from AGI as an other itemized deduction limited in amount to the gambling winnings included in gross income.

5. ($1,000) Although a federal income tax refund can be excluded from gross income, interest on the refund must be included in gross income.

6. ($0) Stock dividends are generally excluded from gross income because a shareholder's relative interest in earnings and assets is unaffected.

Time on Task: 12 minutes

Chapter 7—Income from Services End-of-Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Medium Learning Objective 1: 7.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.1 Solution: Examples of items of income that are considered compensation include wages earned, tips earned, taxable prizes, and awards paid to employees, certain fringe benefits, certain employee business expense reimbursements, and taxable cost of group-term life insurance in excess of $50,000, among others.

Time on Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Easy Learning Objective 1: 7.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.1 Solution: Yes, Andy does need to include the unreported tips in his taxable income. It is earned income for services provided.

Time on Task: 2 minutes 3) Title: Discussion Question 3 Difficulty: Medium Learning Objective 1: 7.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.2 Solution: An employee fringe benefit is an extra benefit supplementing an employee's salary, such as use of a company automobile, subsidized meals, or health insurance premiums. Individuals must include the fair market value of a fringe benefit in income as wages unless Congress has excluded it.

1

Time on Task: 2 minutes 4) Title: Discussion Question 4 Difficulty: Hard Learning Objective 1: 7.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.2 Solution: Congress uses the term discrimination in this context to apply to one measure to categorize employees: highly compensated employees versus non-highly compensated employees. Most fringe benefits cannot discriminate against non–highly compensated employees if the value of the benefit will be excluded for highly compensated employees. That is, the business cannot extend the benefit to only those who are highly compensated if the highly compensated want to achieve a favorable tax result. If a benefit is discriminatory, then the law taxes the highly compensated employees on the fair market value of the benefit. The law does not tax non–highly compensated employees on the value of the benefit if it is otherwise excludable.

Time on Task: 4 minutes 5) Title: Discussion Question 5 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.3 Solution: Examples of a nontaxable employee fringe benefit include premiums for health insurance, disability insurance and long-term care insurance paid by employers, employer provided life insurance up to $50,000, the value of food and lodging provided by the employer in some circumstances, working condition fringe benefits, de minimis benefits, no additional cost services provided by employer, discounts, nominal gifts under $25, and transportation and parking up to $315 per month (2024), among others.

Time on Task: 4 minutes 6) Title: Discussion Question 6 Difficulty: Easy Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 2

Solution: Yes, because the movie passes are treated as gift certificates which is like cash.

Time on Task: 1 minute 7) Title: Discussion Question 7 Difficulty: Easy Learning Objective 1: 7.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.3 Solution: The employee can exclude from income up to $400 if awarded under a nonqualified plan, and up to $1,600 if the plan is qualified for safety and length of service awards. The length of service award can be excluded up to $7,500 for bona fide volunteers engaged in firefighting, emergency medical services, and ambulance services.

Time on Task: 2 minutes 8) Title: Discussion Question 8 Difficulty: Medium Learning Objective 1: 7.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.4 Solution: A stock option gives an individual the right, but not the obligation, to buy or sell a stock at an agreed upon price by a certain date. An incentive stock option provides superior tax results for the employee because the employee can tax the gain at long-term capital gain rates if certain conditions are met.

Time on Task: 3 minutes 9) Title: Discussion Question 9 Difficulty: Medium Learning Objective 1: 7.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.4 Solution: A stock option that does not qualify as an ISO is a nonqualified stock option. Ordinary income is recognized at the exercise date.

Time on Task: 2 minutes 3

10) Title: Discussion Question 10 Difficulty: Medium Learning Objective 1: 7.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.5 Solution: An accountable plan is a written plan that adheres to strict requirements for reimbursing workers for business expenses so that the employee does not have income for the reimbursements. Without an accountable plan, the employer must include all the reimbursements as wages on the W-2.

Time on Task: 2 minutes 11) Title: Discussion Question 11 Difficulty: Medium Learning Objective 1: 7.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.6 Solution: A defined contribution plan is a qualified retirement plan for which the employee, and at times the employer, contributes pre-taxed salary to the plan. Defined benefit plans are qualified plans for which the employer promises the employee a benefit in retirement based on a formula that usually includes the number of years of service and the employee’s salary. Employees manage the investment of their defined contribution plan, whereas the employer manages the investment of funds for defined benefit plans.

Time on Task: 4 minutes 12) Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 7.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.7 Solution: No, the employee has no basis in the retirement plan. The employer provided all the contributions and the earnings in the account have accumulated tax free until distribution.

Time on Task: 2 minutes

4

13) Title: Discussion Question 13 Difficulty: Medium Learning Objective 1: 7.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.7 Solution: A few examples of exceptions to the 10% penalty are distribution used when the taxpayer is deemed to be terminally ill by a physician, distributions used for first time home buyers up to $10,000, distributions for qualified higher education expenses, distributions made in the form of certain periodic payments over the taxpayer’s remaining life expectancy, distributions used to pay medical expenses in excess of the allowable percentage of AGI for the current year, which is 7.5% of AGI, and distributions made by individuals called or ordered to active military duty, among others.

Time on Task: 4 minutes 14) Title: Discussion Question 14 Difficulty: Medium Learning Objective 1: 7.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.7 Solution: A distribution from a traditional IRA is taxable as ordinary income to the extent it exceeds the taxpayer’s basis in the IRA. A distribution from a Roth IRA is not taxable. Both may be subject to a 10% premature penalty if the taxpayer is not at least age 59 1/2 and an exception has not been met.

Time on Task: 4 minutes 15) Title: Discussion Question 15 Difficulty: Medium Learning Objective 1: 7.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.7 Solution: An annuity is a fixed sum of money paid to someone each year, usually for the rest of their life.

A single life annuity is paid out over the life of the employee who owns the annuity. Some employees have the option to choose a joint annuity, which pays the annuity out over the life of the employee and the employee’s spouse.

5

Time on Task: 3 minutes 16) Title: Discussion Question 16 Difficulty: Medium Learning Objective 1: 7.8 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.8 Solution: Yes, Social Security benefits (SSB) can be taxable depending on the taxpayer’s provisional income. The amount of SSB included in taxable income is either 0%, 50%, or 85%. Provisional Income = AGI (before SSB) + Tax-exempt interest + 50% (SSB).

Time on Task: 2 minutes 17) Title: Discussion Question 17 Difficulty: Medium Learning Objective 1: 7.9 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.9 Solution: Qualifying individuals can elect to exclude foreign-earned income. For 2024, the foreign earned income exclusion is $126,500.

Time on Task: 2 minutes 18) Title: Discussion Question 18 Difficulty: Medium Learning Objective 1: 7.9 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.9 Solution: Cedric is taxed on all his income earned regardless of where it is earned. Cedric can be taxed in the U.S. and the foreign countries. Three provisions mitigate the potential double taxation of this income: a. Foreign income taxes paid are an itemized deduction for individuals. b. Alternatively, the taxpayer may claim a credit for foreign taxes paid. c. Qualifying individuals can elect to exclude foreign-earned income Time on Task: 4 minutes

6

Multiple Choice Questions 1) Answer: b Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 7.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.1 Solution: The correct answer is Form W-2.

Form W-2 is a wage earner’s statement that reflects wages earned and taxes withheld. Box 1 of Form W-2 must be shown as taxable wages on Line 1 of Form 1040.

Time on Task: 1 minute 2) Answer: d Title: Multiple Choice Question 2 Difficulty: Medium Learning Objective 1: 7.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.2 Solution: The correct answer is The discrimination rules do not apply to any of these.

The discrimination rules do not apply to the following fringe benefits: a. Health insurance premiums (if plan is not self-insured) b. Working condition fringe benefits c. Transportation and parking fringe benefits d. Lodging on the employer's premises e. De minimis fringe benefits Time on Task: 3 minutes 3) Answer: d Title: Multiple Choice Question 3 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.3 Solution: 7

The correct answer is All of these are taxable fringe benefits.

Gym memberships not on the employer’s premises, season tickets to the Chicago Cubs games, and below market interest rate loans are all taxable fringe benefits and must be included in the employee’s income.

4) Answer: d Title: Multiple Choice Question 4 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.3 Solution: The correct answer is All of the these are nontaxable fringe benefits.

Health insurance premiums paid by the employer, group term life insurance under $50,000, and employee educational assistance up to $5,250 are all nontaxable fringe benefits.

Time on Task: 3 minutes 5) Answer: a Title: Multiple Choice Question 5 Difficulty: Easy Learning Objective 1: 7.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.3 Solution: The correct answer is Tip income.

Tip income must be reported as taxable income. An employee discount of 20%, health insurance premiums paid by the employer, and soft drinks and coffee provided by the employer are nontaxable fringe benefits.

Time on Task: 2 minutes 6) Answer: b Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: 8

The correct answer is Reimbursement of $225 for her subscription to Air Travel Business Journal.

The lodging is not excluded because she works in the airline division. The life insurance exclusion is limited to $50,000 of coverage. Free use of a company owned vehicle is a taxable fringe benefit. The reimbursement for her subscription to Air Travel Business Journal is a nontaxable working condition fringe benefit.

Time on Task: 4 minutes 7) Answer: c Title: Multiple Choice Question 7 Difficulty: Easy Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: The correct answer is $500.

The maximum exclusion for safety and length of service awards under a qualified plan is $1,600.

Therefore, $500 must be included in income.

Time on Task: 2 minutes 8) Answer: d Title: Multiple Choice Question 8 Difficulty: Medium Learning Objective 1: 7.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.4 Solution: The correct answer is The date the stock is sold.

The employee recognizes income on an incentive stock option when the stock is sold.

Time on Task: 2 minutes 9) Answer: b Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 7.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.5 9

Solution: The correct answer is Plan that requires the employee to substantiate the expenses and return any excess reimbursement.

The reimbursement of employee business expenses is not taxable to the employee if the employer has a plan that requires the employee to substantiate the expenses and return any excess reimbursement.

Time on Task: 3 minutes 10) Answer: c Title: Multiple Choice Question 10 Difficulty: Medium Learning Objective 1: 7.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.6 Solution: The correct answer is April 15, 2025.

Taxpayers can make IRA contributions up to the original due date of the return, April 15, to be deductible for the previous tax year.

Time on Task: 2 minutes 11) Answer: d Title: Multiple Choice Question 11 Difficulty: Medium Learning Objective 1: 7.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.7 Solution: The correct answer is $900,000.

Sam must include $900,000 in gross income. He has no basis for his employer’s contributions nor for his contributions because he was not taxed on the contribution when they were made to his retirement fund.

Time on Task: 3 minutes 12) Answer: d Title: Multiple Choice Question 12 Difficulty: Medium Learning Objective 1: 7.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting 10

Standard 3: Bloom's || Knowledge Section Reference 1: 7.7 Solution: The correct answer is All of the these are allowed exceptions.

Exceptions to paying the 10% premature distribution penalty include the taxpayer being 59 ½ years old, if the taxpayer died during the year, and the taxpayer being permanently disabled.

Time on Task: 3 minutes 13) Answer: c Title: Multiple Choice Question 13 Difficulty: Easy Learning Objective 1: 7.8 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.8 Solution: The correct answer is 85%.

Inclusion of Social Security benefits in taxable income will never exceed 85% of the benefits received.

Time on Task: 2 minutes 14) Answer: d Title: Multiple Choice Question 14 Difficulty: Medium Learning Objective 1: 7.8 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.8 Solution: The correct answer is $0.

Ethyl’s modified adjusted gross income is less than $25,000 for a single taxpayer so none of her Social Security benefits are taxed. Ethyl’s provisional income = pension income + 50% (SSB) = $10,000 + 50% of 17,000 = $18,500 < BA1 of $25,000.

15) Answer: c Title: Multiple Choice Question 15 Difficulty: Easy Learning Objective 1: 7.9 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge 11

Section Reference 1: 7.9 Solution: The correct answer is Form 2555.

Form 2555 is used to claim the foreign earned income exclusion.

Time on Task: 1 minute Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 7.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.1 Solution: Yes, Emelda must report all income earned of $10,800 including tips. It does not matter that the income was not reported on wage earnings statements. It is earned income and must be reported.

Time on Task: 3 minutes 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: Shaquille must include all payments and benefits in income except for the health insurance and Long-term disability insurance. If only the top five executives are receiving the other benefits, then the plan is discriminatory and must be included in income. Shaquille’s total income from GKI is $1,221,100.

Time on Task: 3 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 7.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.4 Solution: The key dates are as follows: 12

• The grant date is March 10, Year 2.

• The exercise date is December 10, Year 3.

• The sale date is April 15, Year 4.

Time on Task: 4 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 7.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.5 Solution: Yes, because the expenses are reimbursed under a nonaccountable plan, Tyrone will be taxed on the $420 reimbursement, and he will not receive a deduction for the expense either.

Time on Task: 3 minutes 5) Title: Brief Exercise 5 Difficulty: Hard Learning Objective 1: 7.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.6 Solution: Bryn will have to pay taxes if she converts her traditional IRA to a Roth IRA. Her income from the conversion would be $540,000 ($680,000 value − $140,000 basis). Her tax liability from the conversion would be $199,800 ($540,000  37%). The conversion will usually be beneficial for Bryn if she is not already close to retirement age, and she has other funds to use to pay the $199,800 of taxes. It would not be wise if Bryn would need to take a distribution from her IRA to pay the taxes.

Time on Task: 5 minutes 6) Title: Brief Exercise 6 Difficulty: Medium Learning Objective 1: 7.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.7 Solution:

13

A penalty of 10% will not be imposed if the taxpayer has died or in any of the following situations: •

Made in the form of certain periodic payments over the taxpayer’s remaining life expectancy.

• Used to pay medical expenses in excess of the allowable percentage of AGI for the current year, which is 7.5% of AGI. • Used to purchase health insurance of an individual who is unemployed for at least 12 weeks, • Used for a taxpayer who is deemed to be terminally ill by a physician, • For first-time home buyer expenses (limited to $10,000), • Distributed for qualified higher education expenses, • Used to pay expenses incurred related to damages from a federally declared disaster area (limited to $22,000, and these distributions are included in income over three years), • The IRS has levied the taxpayer’s assets, • Made by individuals called or ordered to active military duty, or • Made during the one-year period beginning with the date of the birth of the individual's child or on the date the individual finalizes an adoption (excluding adoption of the child of the taxpayer's spouse). The tax law limits this exception to $5,000.

Time on Task: 6 minutes 7) Title: Brief Exercise 7 Difficulty: Medium Learning Objective 1: 7.8 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.8 Solution: A single taxpayer will only have to pay tax on their Social Security benefit if their provisional income is more than their base amount of $25,000. A married taxpayer will only have to pay tax on their Social Security benefit if their provisional income is more than their base amount of $32,000. Provisional income = AGI (before SSB) + Tax-exempt interest + 50% (SSB).

Time on Task: 3 minutes 8) Title: Brief Exercise 8 Difficulty: Medium Learning Objective 1: 7.9 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 7.9 Solution: 14

One of these two tests need to be met for a qualifying individual to exclude foreign earned income, as follows: a. During a continuous period that includes an entire tax year, the individual must be a bona fide resident of at least one foreign country. b. The individual must have a tax home in a foreign country and must meet the physical presence test: they must have been present in one or more foreign countries for at least 330 days during any 12 consecutive months. The 330 days do not have to fall in one tax year but must be during a consecutive 12-month period.

Time on Task: 5 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium Learning Objective 1: 7.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.1 Solution: Marco’s total income from employment is $46,450 ($15,600 + $1,850 + $6,800 + $1,200 + $21,000). All wages and tips are taxable income.

Time on Task: 5 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 7.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.1 Solution: Dominique must include in her taxable income $58,900 ($55,000 + $400 + $500 + $3,000). The 10% discount is a nontaxable fringe benefit. The $3,000 cash received is taxable because cash was chosen as part of her cafeteria plan.

Time on Task: 4 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 7.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application 15

Section Reference 1: 7.2 Solution: Only the short-term disability premiums of $600 must be included in Desmond’s income. None of the other benefits are included in Desmond’s income. Premiums for health insurance, longterm disability insurance, and long-term care insurance paid by employers to cover its employees are excluded from income.

Time on Task: 4 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 7.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.2 Solution: Francis does not have to include the $9,300 in income because he paid for the short-term disability premiums himself.

Time on Task: 3 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 7.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.2 Solution: Francis must include $3,720 ($9,300  40%) in income. Francis must include the portion of the payment received that is attributable to the employer-paid premiums for disability.

Time on Task: 4 minutes 6) Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 7.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.2 Solution: Neither Gargoyle Inc nor the CFO include anything in income. Life insurance proceeds are excludable from income whether received by the company or the CFO’s beneficiaries.

Time on Task: 3 minutes 16

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7) Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 7.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.2 Solution: Lee must report $223 in his income. $174,000 − $50,000 exclusion = $124,000, which is 124 taxable units at $1.80 each.

Time on Task: 4 minutes 8) Title: Application Problem 8 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: The $265 a month for parking is a non-taxable fringe benefit up to $315 per month. The value of his lodging ($550 per month) is considered a no-additional-cost-service benefit. Roger is a highly compensated employee. The parking benefit allows discrimination in favor of highly compensated employees. However, the no-additional-cost-service benefit does not allow discrimination. Because Roger is highly compensated, the value of his lodging is taxable to him.

Roger must include $6,600 ($550  12) in his taxable income.

Time on Task: 4 minutes 9) Title: Application Problem 9 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: Season tickets to the University of Tennessee football games, five-day stay at the company property in California at no cost, and an automobile allowance are taxable fringe benefits. The rest are nontaxable fringe benefits provided by an employer. The employer contribution to a pension plan will be taxable upon distribution to the employee when it is withdrawn by the employee.

Time on Task: 6 minutes 17

10) Title: Application Problem 10 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: a. Allowing employees to fly for free if seats have not been sold is considered a nontaxable no additional cost service fringe benefit. b. The hotel managers living at FUN Hotel for free must include the benefit in income.

Hotel managers are taxed on fair market value of the free-living arrangement because living at the hotel is not required. c. The limit on the discount for purchases of merchandise is the average gross profit percentage for the employer. Because the employee discount of 30% is less than the gross profit percentage of 35%, it is not taxable. d. Taxpayers can exclude de minimis fringe benefits because they are small in value and infrequent. The free access to coffee and/or soda during the workday is a de minimis fringe benefit. e. Dependent care assistance provided by the employer is allowed up to $5,000 and not taxable to the employee. f. Reimbursement for mass transit passes provided by employers is allowed up to $315 and not taxable to the employee. g. The value of nominal gifts to employees is excluded up to $25 per employee, as long as the gifts are not paid in cash, gift cards, or gift certificates. h. Employers are allowed to give an employee achievement award for safety or length of service and the employee can exclude up to $1,600 if the plan is qualified and up to $400 if the plan is not qualified.

Time on Task: 10 minutes 11) Title: Application Problem 11 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: $0 is taxable to Anthony. He is a volunteer EMT and can exclude up to $7,500 for a length of service award.

Time on Task: 3 minutes 12) 18

Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: Both the value of the catered meals and the meals reimbursed can be excluded from Ken’s income. The catered food is provided by the employer for the employer’s convenience and the purchased food is a working condition fringe benefit. A working condition fringe benefit can be excluded from income by highly compensated employees even if the benefit is discriminatory.

Time on Task: 4 minutes 13) Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: MBI is allowed to offer employees a qualified discount of up to $600 ($2,400  25%). Because Kelly’s discount of $2,400 ($0 paid less $2,400 retail price) exceeds the allowable discount of $600, she must include $1,800 in gross income ($2,400 − $600). Employee discounts only qualify as an allowable qualified employee discount to the extent they do not exceed the employer’s gross profit percentage.

Time on Task: 5 minutes 14) Title: Application Problem 14 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: Imamu must include $35 per month ($350 − $315) in his income. Up to $315 per month can be received as a tax-free fringe benefit for transportation. Transportation and parking can be excluded from income by highly compensated employees even if the benefit is discriminatory.

Time on Task: 4 minutes 15) Title: Application Problem 15 19

Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: Zaire must include in his income $4,750 ($10,000 received − $5,250 allowable exclusion for educational assistance). The other benefits are nontaxable fringe benefits. The contribution to the employer retirement plan will be taxable upon distribution to the employee when it is withdrawn by the employee.

Time on Task: 3 minutes 16) Title: Application Problem 16 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: Luther must include in his income: • • •

Moving expense reimbursement $2,200 (This is not an excludable benefit unless Luther was in the military.)

Reimbursement of athletic club membership $1,600 (This is not an excludable benefit because the athletic facility was not on the employer’s premises nor owned by his employer.)

Reimbursement for adoption $3,190 ($20,000 − $16,810). Luther may exclude up to $16,810 in 2024 for a qualified adoption.

The retirement advice and the fruit basket are excludable employee fringe benefits.

Time on Task: 6 minutes 17) Title: Application Problem 17 Difficulty: Medium Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.3 Solution: Eleanor has taxable wages of $1,400. She spent only $8,600 of the cash allocated to her on fringe benefits. Eleanor retains the additional $1,400 of cash and she must recognize this as wages.

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Time on Task: 5 minutes 18) Title: Application Problem 18 Difficulty: Medium Learning Objective 1: 7.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.4 Solution: Carlotta will report $0 in Year 2 and $750 in Year 5. No income is recognized when a stock option is exercised (Year 2). Income in Year 5 is determined as: $4,800 (150  $32) (4,050) (150  $27) $ 750

Amount Realized Less: Adjusted Basis Recognized Gain

The gain is a long-term capital gain because the two-year holding period requirement was met: • •

The stock was owned from Year 2 to Year 5, more than 1 year.

The time from the grant date in Year 1 to the sale date in Year 5 is more than 2 years.

Time on Task: 5 minutes 19) Title: Application Problem 19 Difficulty: Medium Learning Objective 1: 7.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.4 Solution: Grant date—No gain recognized Exercise date – FMV of stock price Exercise price Excess  Number of shares exercised Ordinary income

$40 ( 15) $25  2,000 $50,000

Sale date – $130,000 (2,000  $65) ( 80,000) [(2,000  $15) + $50,000] $ 50,000

Amount realized Less: Adjusted basis Recognized gain 21

The gain is long-term capital gain because the stock was owned for more than one year before selling it.

Time on Task: 6 minutes 20) Title: Application Problem 20 Difficulty: Hard Learning Objective 1: 7.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.4 Solution: Phoebe has ordinary income of $12,000 (200  $60) on the grant date and Friends, Inc. has a $12,000 deduction because the option has a readily ascertainable fair market value. Phoebe also has basis in the stock options of $12,000. Phoebe has no other tax consequences until she sells the stock, as follows: Amount realized Less: Adjusted basis Recognized gain Time on Task: 6 minutes

$35,000 (34,000) $ 1,000

($175  200) ($110  200) + $12,000 Long-term capital gain

21) Title: Application Problem 21 Difficulty: Medium Learning Objective 1: 7.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.5 Solution: a. Under an accountable plan, Darlene will receive reimbursement for all the business expenses and will not have to include any of it as income. b. Under a non-accountable plan, Darlene will have to include all $7,565 as taxable income and she will not be able to take a deduction for employee business expenses under current law.

Time on Task: 6 minutes 22) Title: Application Problem 22 Difficulty: Hard Learning Objective 1: 7.6 Standard 1: AACSB || Analytic 22

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.6 Solution: a. They would be allowed a contribution of $7,000 each. Donald and Daisy have a combined earned income of $80,000 which is less than the beginning of the phaseout range of $123,000 for married filing jointly, so they can both deduct $7,000. b. They would be allowed a contribution of $7,000 each. If one spouse (Daisy) does not have sufficient earnings to contribute $7,000, she can use earnings from the other spouse to justify the contribution. Donald and Daisy have a combined earned income of $68,000 which is less than the beginning of the phaseout range of $123,000 for married filing jointly, so they can both deduct $7,000. c. They would be allowed a contribution of $7,000 each. Donald and Daisy have a combined earned income of $131,000 which exceeds the beginning of the phaseout range of $123,000 for married filing jointly. Their modified AGI exceeds the threshold of $123,000 by $8,000 ($131,000 − $123,000). Therefore, Donald and Daisy lose 40% ($8,000/$20,000) of their deduction, or $5,600 ($14,000  40%). Their IRA contribution is $14,000 and their IRA deduction is $8,400 ($14,000 − $5,600). d. They would be allowed a contribution of $7,000 each and Donald would be allowed an additional $1,000 catch-up contribution because he is over 50 years old. Donald and Daisy have a combined earned income of $80,000 which is less than the beginning of the phaseout range of $123,000 for married filing jointly. Their total IRA contribution and deduction is $15,000. e. They would be allowed a contribution and deduction of $7,000 each. The IRA deduction is not limited based on AGI when taxpayers are not active participants in another qualified retirement plan.

Time on Task: 12 minutes 23) Title: Application Problem 23 Difficulty: Hard Learning Objective 1: 7.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.6 Solution: a. If their modified AGI was $103,000, Akina has a $7,000 deduction because she is an active participant, and their modified AGI is less than $123,000, which is the beginning of the phaseout range for married filing jointly. Because Russ is not an active participant, he can deduct his $7,000 contribution as well.

23

b. If their modified AGI was $145,000, Akina has no deduction because she is an active participant and their modified AGI exceeds $143,000, which is the top of the phase-out range for married filing jointly. Because Russ is not an active participant, he can deduct his $7,000 contribution. c. If their modified AGI is $235,000, Akina still has no deduction. Russ must reduce his deduction because their modified AGI exceeds $230,000. Their excess AGI is $5,000 ($235,000 − $230,000). The phase-out percentage is 50% ($5,000/$10,000). So, Russ loses $3,500of his deduction ($7,000  50%) and he can deduct $3,500 ($7,000 − $3,500). The phase-out range is $10,000 because only one spouse is an active participant.

Time on Task: 8 minutes 24) Title: Application Problem 24 Difficulty: Hard Learning Objective 1: 7.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.6 Solution: a. If their modified AGI is $236,000, they must reduce their contribution as follows: ($236,000 − $230,000)/$10,000  $7,000 = $4,200.

They can each contribute $2,800 ($7,000 − $4,200) to their Roth IRA. b. Because these are Roth IRAs, none of the contributions are deductible.

Time on Task: 4 minutes 25) Title: Application Problem 25 Difficulty: Medium Learning Objective 1: 7.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.6 Solution: Bernice’s retirement benefit will be $90,000 (3%  20 years  $150,000).

Time on Task: 3 minutes 26) Title: Application Problem 26 Difficulty: Medium Learning Objective 1: 7.6 24

Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.6 Solution: Because Duke is age 50 or over, he can contribute $30,500 to his 401(k) plan ($23,000 + $7,500). His employer matches $5,680 of his contribution ($142,000  4%). The total contributed to his 401(k) plan this year is $36,180 ($30,500 + $5,680).

Time on Task: 4 minutes 27) Title: Application Problem 27 Difficulty: Hard Learning Objective 1: 7.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.6 Solution: a. The employer may contribute the lesser of: 1. 25% of the employee's compensation; or 2. $69,000.

Therefore, the maximum contribution is $25,000 ($100,000  25%). b. The employer may contribute the lesser of: 1. 25% of the employee's compensation; or 2. $69,000.

Therefore, the maximum per the formula is $62,500 ($250,000  25%), but the contribution cannot exceed $69,000.

Time on Task: 6 minutes 28) Title: Application Problem 28 Difficulty: Medium Learning Objective 1: 7.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.7 Solution: The total tax cost of the withdrawal would be:

25

Income tax Premature distribution penalty Total tax cost

$2,400 ($10,000  24%) 1,000 ($10,000  10%) $3,400

The rest of the distribution is not taxed or penalized because it was rolled over within 60 days of receipt.

Time on Task: 4 minutes 29) Title: Application Problem 29 Difficulty: Medium Learning Objective 1: 7.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.7 Solution: If Reginald does not take the distribution, the IRS will require Reginald to pay a 25% penalty of $6,500 ($26,000  25%).

Time on Task: 3 minutes 30) Title: Application Problem 30 Difficulty: Medium Learning Objective 1: 7.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.7 Solution: The amount of the annuity payments Nellie must include in income can be calculated as follows: Step 1. Her annuity is $2,500 per month.

Step 2. Per Illustration 7.11, because Nellie is 68 when the annuity payments begin, her life expectancy is 210 months.

Step 3. Her expected return is $525,000 ($2,500  210 months).

Step 4. Her exclusion ratio is 42.86% ($225,000 cost/$525,000 expected return). Her total payments this year were $17,500 ($2,500  7 months) and she can exclude $7,501 ($17,500  42.86%).

Nellie must include $9,999 ($17,500 − $7,501) in income this year.

Time on Task: 6 minutes

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31) Title: Application Problem 31 Difficulty: Medium Learning Objective 1: 7.8 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.8 Solution: a.

Pension Distribution Municipal Interest Income 50%  SSB ($24,000) Provisional income

$25,000 1,000 12,000 $38,000 which falls between $32,000 and $44,000

Taxable SSBs = $3,000; the lesser of: (a) 50% of SSBs, or $12,000 (b) 50% [(Provisional Income ($38,000)) − $32,000], or $3,000 b.

Pension Distribution Municipal Interest Income 50%  SSB ($24,000) Provisional income

$40,000 1,000 12,000 $53,000 which falls above $44,000

Taxable SSBs = $13,650; the lesser of: (a) 85% of SSBs, or $20,400 (b) 85% [(Provisional Income ($53,000)) − $44,000] = Plus, lesser of (1) $6,000 or (2) 50%  SSBs ($12,000) Total Time on Task: 8 minutes

$7,650 6,000 $13,650

32) Title: Application Problem 32 Difficulty: Medium Learning Objective 1: 7.8 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.8 Solution: Pauline’s Provisional Income = AGI (before SSB) + Tax-exempt interest + 50% (SSB) = $60,000 + $3,300 + $8,750 = $72,050 which is above $34,000 Taxable SSBs = $14,875; the lesser of: 27

(a) 85% of SSBs, or $14,875 (b) 85% (Provisional Income $72,050 − $34,000) = $32,343 Plus, lesser of (1) $4,500 or (2) 50% SSBs $8,750 4,500 Total $36,843 Pauline will be taxed on $14,875 of her SSBs. Time on Task: 5 minutes 33) Title: Application Problem 33 Difficulty: Hard Learning Objective 1: 7.9 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.9 Solution: The foreign earned income exclusion for 2024 is $126,500 so Santos will have to report $100,500 ($227,000 − $126,500) of taxable income on his Form 1040. Additionally, Santos could deduct as an itemized deduction or claim a foreign tax credit based on the German income tax attributable to his taxable salary of $100,500.

Time on Task: 4 minutes 34) Title: Application Problem 34 Difficulty: Medium Learning Objective 1: 7.9 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 7.9 Solution: The number of full days Carol was in Sweden is (travel days do not count because she was not in Sweden the whole day) 348 days: January February March April May June July August September October

17 28 31 30 31 30 31 31 30 31 28

November December

30 28

Exclusion = $126,500  348/365 = $120,608 Taxable salary = $154,392 ($275,000 − $120,608) Time on Task: 5 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Medium Learning Objective 1: 7.4 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 7.4 Solution: a.

The grant date is February 1, Year 8 The vesting date is August 1, Year 8 The exercise date is June 5, Year 9 The sale date is August 6, Year 11 b. Hanifah will have long-term capital gain on the sale because she held the shares for more than two years between the grant date and the sale date and she held the shares for more than one year between the exercise date and the sale date.

Amount realized $185,000 (1,000 shares  $185 sale price per share) Less: Adjusted basis ( 150,000) (1,000 shares  $150 exercise price per share) Recognized gain $ 35,000 The recognized gain is a long-term capital gain because this was a qualifying disposition of stock. c. If Hanifah had sold her shares on June 1, Year 10, she would not have held the shares for more than one year between the exercise date and the sale date. This transaction would be a disqualifying disposition.

On the sale date, Hanifah’s income is computed in two steps: First, she has ordinary income equal to: ($170

−

$150)

 1,000 shares

Her basis per share increases by $20 to $170.

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= $20,000

Second, compute the capital gain or loss as: Amount realized Less: Adjusted basis Recognized gain

$185,000 (170,000) $ 15,000

($185  1,000 shares) ($170  1,000 shares)

The gain is short-term capital gain because Hanifah did not hold onto the stock for more than one year.

Hanifah should hold onto the stock until at least June 6, Year 10 so that all of the $35,000 gain is long-term capital gain.

Time on Task: 12 minutes 2) Title: Tax Planning Problem 2 Difficulty: Medium Learning Objective 1: 7.7 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 7.7 Solution: Sadie is 58 so she will have to pay tax on the distributions as ordinary income, and she would be subject to the 10% premature distribution penalty. To avoid this, Sadie could use up to $10,000 from her IRA as a first-time homebuyer to avoid the 10% penalty on that $10,000. She could also retire and collect periodic payments from her pension plan. It would be considered ordinary income and taxed, but the 10% penalty does not apply to distributions from other qualified plans for an employee after separation from service if age 55 or older. Lastly, Sadie could wait until she is 59 and ½ to avoid all premature distribution penalties. She would then only pay tax on the ordinary income received.

Time on Task: 5 minutes Professional Development Skills Communication Problem 1) Title: Communication Problem: Taxation of Retirement Income Difficulty: Medium Learning Objective 1: 7.6 Learning Objective 2: 7.8 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 7.6, 8 30

Solution: Memo to Client Dear Dennis and Sharon, Congratulations on your upcoming retirement! I am glad that you will now be able to travel and see the world. I have prepared a calculation to determine how much you can withdraw from your 401(k) without your Social Security benefits (SSBs) being included in your taxable income.

If your modified adjusted gross income plus one half of the SSBs is under $32,000, then none of your SSBs will be taxed. So, you may withdraw up to $21,000 from your 401(k) [$21,000 + ($22,000  50%) = $32,000] and none of the SSBs will be taxed.

Please be aware that if you withdraw more than $21,000 from the 401(k), then up to 50% or even 85% of your SSBs will be included in your income. Contact me immediately if you think you need to withdraw more than $21,000 and I can prepare this calculation for you.

Enjoy your travels and retirement.

Sincerely, Carnes & Youngberg, CPAs Tax Memo to the file Facts: Dennis and Sharon, ages 67 and 65, are planning on retiring at the end of the year. Their Social Security benefits (SSBs) will be $22,000 per year.

Issue: How much may Dennis and Sharon withdraw from their 401(k) without their SSBs being included in income and subject to tax?

Conclusion: Dennis and Sharon may withdraw up to $21,000 from their 401(k) without their SSBs being included in income and subject to tax.

Analysis: Under IRC §86(b)(1), SSBs can be taxed depending on the amount of modified adjusted gross income (MAGI) plus one half of SSBs in excess of the base amount. The base amount for a couple filing jointly is either $32,000 or $44,000 depending on the level of MAGI. If the modified adjusted gross income plus one half of the SSBs is under $32,000, then none of the SSBs will be taxed. Dennis and Sharon may withdraw up to $21,000 from their 401(k) [$21,000 + ($22,000  50%) = $32,000] and none of the SSBs will be taxed.

Time on Task: 15 minutes Ethics Problem 1) Title: Ethics Problem: Foreign Earned Income 31

Difficulty: Medium Learning Objective 1: 7.9 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 7.9 Solution: When foreign income is earned, the taxpayer generally has two choices. They can elect to include the foreign earned income in their taxable income and then claim a credit for foreign taxes paid, or they can exclude up to $126,500 (2024) of foreign earned income from their U.S. gross income. Deducting foreign taxes paid as an itemized deduction is a third option, although it is generally less beneficial than the other two options. Because Paige earned $200,000 in each of the previous years, she must choose one of the alternatives. It would probably be best to exclude a portion of her income earned and report the rest as taxable income. Amended tax returns will be needed for Paige for the years that she did not report any foreign earned income.

Per Circular 230 §10.21 Knowledge of client’s omission, the tax preparer must advise the client promptly of the fact of such noncompliance, error, or omission. The practitioner must advise the client of the consequences as provided under the Code and regulations of such noncompliance, error, or omission. Also, in the AICPA’s Statement on Standards for Tax Services No. 1.2.6, Knowledge of Errors, "a member should promptly inform a taxpayer upon becoming aware of the taxpayer’s failure to file a required return, [or] an error in a previously filed return."

Time on Task: 10 minutes Research Problem 1) Title: Research Problem 1: Working Condition Fringe Benefit Difficulty: Difficult Learning Objective 1: 7.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 7.3 Solution: This situation is very similar to Townsend Indus. v. United States - 342 F.3d 890 (8th Cir. 2003).

The IRS and District Court ruled that the payment for a fishing trip provided by the employer is considered wages and therefore, taxable to each employee. Withholding for income tax and Social Security and Medicare taxes is required as well. However, in Townsend, the Circuit Court of Appeals overruled this conclusion and found in favor of the taxpayer. The question of whether the per-employee cost of the trips amounted to taxable wages and whether Townsend should have withheld a portion of these costs turns on whether each employee could have deducted these costs as business expenses. §162(a)(2) allows a deduction for traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away 32

from home in the pursuit of a trade or business. §1.162-2(a) provides that only such traveling expenses that are reasonable and necessary in the conduct of the taxpayer's business and directly attributable to it may be deducted. However, §132(d) of the Internal Revenue Code excludes "working condition fringe" benefits from an individual's wages and provides that “working condition fringe” means any property or services provided to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a deduction under §162 or §167. §1.274-2(c)(3) adds four requirements that the taxpayer must meet in order to deduct entertainment and travel expenses. The expense will only be considered directly related to, or associated with, the active conduct of business if: (i) ...the taxpayer had more than a general expectation of deriving some income or other specific trade or business benefit.... (ii) ...the taxpayer actively engaged in a business meeting, negotiation, discussion, or other bona fide business transaction, other than entertainment, for the purpose of obtaining such income or other specific trade or business benefit.... (iii) In light of all the facts and circumstances of the case, the principal character or aspect of the combined business and entertainment...was the active conduct of the taxpayer's trade or business … (iv) The expenditure was allocable to the taxpayer and a person or persons with whom the taxpayer engaged in the active conduct of trade or business during the entertainment...

The District Court determined that Townsend failed to establish a business purpose and ruled in favor of the Government. However, based on testimony presented by Townsend employees and the initial business meeting conducted, the Circuit Court of Appeals felt that a business purpose had been established even though the trip was not required. The Circuit Court determined the trip cost was a working condition fringe benefit and, therefore, not taxable to the employees as wages.

Based on the Circuit Court’s Townsend decision, the cost of the fishing trip is a working condition fringe benefit for Pasquel and the other salespeople and excludable from his wages.

Time on Task: 15 minutes Excel Problem 1) Title: Excel Problem: Taxation of Retirement Income Difficulty: Medium Learning Objective 1: 7.8 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 7.8 Solution:

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a.

Modified AGI = $28,500 ($27,000 pensions + $1,500 tax exempt income) Modified AGI + 50% SSBs = $40,500 is between $32,000 and $44,000 so use: Taxable SSBs = $4,250; Lesser of (a) 50% SSBs = $12,000 or (b) 50% [(Modified AGI + 50% SSBs) − $32,000] = $4,250

b.

Modified AGI = $38,500 ($37,000 pensions + $1,500 tax exempt income) Modified AGI + 50% SSBs = $50,500 is above $44,000 so use: Taxable SSBs = $11,525 ($5,525 + $6,000); Lesser of (a) 85% SSBs = $20,400 or (b) 85% [(Modified AGI + 50% of SSBs) − $44,000] = $5,525, Plus, the lesser of (1) $6,000, or (2) $50% SSBs = $12,000 Total taxable SSBs = $11,525 ($5,525 + $6,000)

c.

Modified AGI = $53,500 ($52,000 pensions + $1,500 tax exempt income) Modified AGI + 50% SSBs = $65,500 is above $44,000 so use: Taxable SSBs = $20,400; Lesser of (a) 85% SSBs = $20,400 or (b) 85% [(Modified AGI + 50% of SSBs) − $44,000] = $18,275, Plus, the lesser of (1) $6,000, or (2) $50% SSBs = $12,000 Total taxable SSBs = $24,275 ($18,275 + $6,000)

However, taxable SSBs in this example can never exceed 85% of SSBs so the correct answer is $20,400. d.

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Time on Task: 20 minutes CPA Exam Preparation: Task-Based Simulation 35

Title: Task-Based Simulation: Calculating Gross Income Difficulty: Medium Learning Objective 1: 7.1 Learning Objective 2: 7.3 Learning Objective 3: 7.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 7.1, 3, 6 Solution: 1. Calculate the taxable portion for dependent care assistance 2. Calculate Harry and Sally’s gross income 3. Calculate the premature distribution penalty

$2,000 $171,050 $400

Rationale 1. The taxable portion of dependent care assistance is $2,000. The assistance of $5,000 stated on the W-2 from Greenway is a nontaxable employee fringe benefit. The maximum is $5,000.

Therefore, the $2,000 of assistance on the W-2 from Applebee’s is in excess of the maximum and must be included in income.

2. Harry and Sally’s gross income is $171,050: Wages from Applebee’s Tip income not reported to Applebee’s Wages from Greenway Excess dependent care benefits Form 1099-R distribution Gross income

$ 48,750 8,300 98,000 2,000 14,000* $171,050

*Only the $6,000 that was rolled over to a qualified plan is exempt from income.

The meals provided to Harry at Applebee’s are a nontaxable employee fringe benefit because it is provided for the convenience of the employer. The length of service award is a nontaxable fringe benefit because it is below $1,600. The tips of $3,000 reported on Form W-2 are already included in wages from Applebee’s. Employers may provide up to $5,000 in nontaxable dependent care benefits. The excess received of $2,000 must be included in gross income as wages.

3. The premature distribution penalty is $400 ($4,000  10%). Harry and Sally are not 59½ years old, so they are subject to a 10% penalty on a premature distribution unless there is a qualifying exception. Being a first-time homebuyer qualifies Harry and Sally for an exception for the distribution that was used to purchase the home. And, they have a qualified roll over of $6,000.

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The $4,000 used to pay off credit cards is not a qualifying exception and is subject to income tax and the 10% penalty.

Time on Task: 10 minutes

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Chapter 8—Framework for Deductions End of Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Medium Learning Objective 1: 8.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.1 Solution: The three mutually exclusive categories are personal, trade or business, and investment.

Expenses related to taxpayer’s personal activities are not deductible unless specifically allowed for by the Internal Revenue Code (IRC). Expenses related to a trade or business activity are deductible if they are related to the business operations and are ordinary, necessary, and reasonable. Expenses related to investment activities or other activities that produce income are deductible if ordinary, necessary, and reasonable.

Time On Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Easy Learning Objective 1: 8.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.1 Solution: Roger will report his sole proprietorship income and expenses on Schedule C. Time on Task: 1 minute 3) Title: Discussion Question 3 Difficulty: Easy Learning Objective 1: 8.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.1 Solution: Garth will report his farming activity on Schedule F. Time on Task: 1 minute

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4) Title: Discussion Question 4 Difficulty: Easy Learning Objective 1: 8.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.2 Solution: The equipment that Nassif purchased for his business is a capital expenditure and must be depreciated over its useful life.

Time on Task: 1 minute 5) Title: Discussion Question 5 Difficulty: Easy Learning Objective 1: 8.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.2 Solution: Bribes, fines, and penalties are violations of public policy and, therefore, not allowed as a tax deduction.

Time on Task: 2 minutes 6) Title: Discussion Question 6 Difficulty: Easy Learning Objective 1: 8.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.2 Solution: No, Genesis cannot deduct the premiums paid for life insurance. No expenses can be deducted if the expense is used to generate tax-exempt income.

Time on Task: 2 minutes 7) Title: Discussion Question 7 Difficulty: Medium Learning Objective 1: 8.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge 2

Section Reference 1: 8.3 Solution: Deductions “for AGI” are expenses used in calculating AGI and are considered above the AGI line. Deductions “from AGI” reduce AGI to arrive at taxable income and are considered below the AGI line.

Time on Task: 2 minutes 8) Title: Discussion Question 8 Difficulty: Easy Learning Objective 1: 8.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.3 Solution: No, if the standard deduction is larger than the total itemized deductions, then the standard deduction is used to calculate taxable income. Therefore, there is no benefit received from the itemized deductions.

Time on Task: 2 minutes 9) Title: Discussion Question 9 Difficulty: Medium Learning Objective 1: 8.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.3 Solution: Depending on the type of payment, a personal expense may be deductible for AGI or as an itemized deduction. An example of a personal expense that is deductible for AGI is student loan interest expense. An example of a personal expense that is deductible from AGI as an itemized deduction is mortgage interest expense. Both are interest expenses but are allowed as deductions in different areas of the individual income tax return.

Time on Task: 2 minutes 10) Title: Discussion Question 10 Difficulty: Hard Learning Objective 1: 8.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.4 Solution: 3

Under the accrual method of accounting, expenses are deductible from gross income in the taxable year in which the all-events test is met. The all-events test is met when it is established that a liability exists, the amount is determined with reasonable accuracy, and economic performance has occurred. Economic performance occurs when the taxpayer receives services or property or uses property another party provided. The law does not permit a deduction until the taxpayer has performed what has been promised under the contract.

Time on Task: 4 minutes 11) Title: Discussion Question 11 Difficulty: Medium Learning Objective 1: 8.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.4 Solution: Hank’s business may take a deduction in Year 2. The bonus was declared by year-end and the amount was fixed and determinable.

Time on Task: 3 minutes 12) Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 8.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.4 Solution: For prepaid expenses related to a business under the cash method, an immediate deduction can be taken when paid as long as the benefits from the expenditure do not extend beyond the earlier of: • •

12 months after benefits first begin or The end of the year after the year in which the taxpayer made the payment.

If the 12-month rule is not met, the deduction must be spread over the period for which the expenses apply.

Time on Task: 3 minutes 13) Title: Discussion Question 13 Difficulty: Medium Learning Objective 1: 8.5 Standard 1: AACSB || Knowledge 4

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.5 Solution: Farmer Fred can expense the repairs to fix the fence, but he must capitalize the cost of a new fence. The cost of the new fence increases the value of the property and substantially increases the property's useful life.

Time on Task: 3 minutes 14) Title: Discussion Question 14 Difficulty: Medium Learning Objective 1: 8.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.6 Solution: No, small businesses do not have to account for inventory under the accrual method. Rather, they can: •

deduct the cost of inventory in the year sold or the year purchased, whichever is later, or • report inventory in the same manner as on the taxpayer's financial accounting statement.

Time on Task: 3 minutes Multiple Choice Questions 1) Answer: d Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 8.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.1 Solution: The correct answer is All of these.

Expenses related to a trade or business activity are deductible if they are related to the business operations and are ordinary, necessary, and reasonable.

Time on Task: 1 minute 2) Answer: c 5

Title: Multiple Choice Question 2 Difficulty: Easy Learning Objective 1: 8.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.1 Solution: The correct answer is Schedule E. Schedule E, page 1 is used to report income and deductions from a rental activity where the owner does not provide substantial services.

Time on Task: 1 minute 3) Answer: b Title: Multiple Choice Question 3 Difficulty: Easy Learning Objective 1: 8.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.1 Solution: The correct answer is Charitable contributions.

Charitable contributions are allowed as an itemized deduction. Groceries, utilities and fuel for personal use are not allowed as deductible personal expenses.

Time on Task: 2 minutes 4) Answer: a Title: Multiple Choice Question 4 Difficulty: Easy Learning Objective 1: 8.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.2 Solution: The correct answer is Cost of goods sold.

Cost of goods sold is the only allowable business expense deduction available for an illegal drug business.

Time on Task: 2 minutes 5) Answer: d Title: Multiple Choice Question 5 6

Difficulty: Easy Learning Objective 1: 8.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.2 Solution: The correct answer is Meals.

Business meals are allowed as a deduction at 50%. Bribes and fines are not deductible as they are against public policy. Entertainment is a nondeductible business expense.

Time on Task: 2 minutes 6) Answer: c Title: Multiple Choice Question 6 Difficulty: Easy Learning Objective 1: 8.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.2 Solution: The correct answer is Pest control expenses for a warehouse where inventory is stored.

The pest control expenses relate to a business and are ordinary, necessary and reasonable. A fine paid is not deductible because it is against public policy. Political contributions and lobbying expenses are not deductible.

Time on Task: 2 minutes 7) Answer: c Title: Multiple Choice Question 7 Difficulty: Easy Learning Objective 1: 8.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.3 Solution: The correct answer is Medical expenses.

Medical expenses paid are deductible as an itemized deduction to the extent the total exceeds 7.5% of adjusted gross income. See Chapter 9, Deductions for AGI and Itemized Deductions, for more details. Student loan interest expense and IRA contributions are deductible above the line as a “for AGI” deduction. The management fee paid for the rental property is a business activity deduction.

Time on Task: 2 minutes

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8) Answer: d Title: Multiple Choice Question 8 Difficulty: Easy Learning Objective 1: 8.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.4 Solution: The correct answer is All of these.

Cash, accrual, and hybrid are all allowable methods of accounting.

Time on Task: 1 minute 9) Answer: b Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 8.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.4 Solution: The correct answer is $1,000.

Prepaid interest must be allocated to the period to which the interest relates, even for cash-basis taxpayers.

Time on Task: 3 minutes 10) Answer: a Title: Multiple Choice Question 10 Difficulty: Medium Learning Objective 1: 8.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.5 Solution: The correct answer is Replacing a small section of a roof.

Replacing a small section of roof is considered a repair and can be expensed. If the entire roof was replaced, then the cost would be capitalized. Replacing a HVAC system, remodeling the interior of your clothing store, and replacing the machinery used on an assembly line are all capitalized costs. All increase the value of the property and/or substantially increase the property’s useful life.

Time on Task: 3 minutes 8

11) Answer: b Title: Multiple Choice Question 11 Difficulty: Easy Learning Objective 1: 8.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.6 Solution: The correct answer is LIFO is used for financial reporting purposes.

A business can use LIFO only if it is also used for financial reporting. During a period of rising prices, LIFO produces a higher cost of goods sold and lower taxable income.

Time on Task: 2 minutes 12) Answer: a Title: Multiple Choice Question 12 Difficulty: Easy Learning Objective 1: 8.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.6 Solution: The correct answer is Gross receipts do not exceed $30 million.

The cash method of accounting may be used if the average gross receipts do not exceed $30 million for the previous three years.

Time on Task: 2 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 8.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.1 Solution: A taxpayer cannot deduct expenses related to personal activities unless specifically provided for in the tax law. Most personal expenses are deducted on Schedule A as an itemized deduction, although some may be deductions for AGI. Some common examples of allowable personal

9

expenses if a taxpayer itemizes their deductions are charitable contributions, mortgage interest expense, and real estate taxes on their principal residence.

Time on Task: 3 minutes 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 8.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.2 Solution: None of the expenses are deductible. The funeral expenses are personal and not deductible.

Lobbying expenses, whether incurred at the state, local, or federal level are not deductible. The bribe is not deductible because it is in violation of public policy.

Time on Task: 3 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 8.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.3 Solution: A deduction for AGI reduces AGI and is always deductible subject to limitations. A deduction from AGI is only deductible if your itemized deductions exceed the standard deduction.

Time on Task: 3 minutes 4) Title: Brief Exercise 4 Difficulty: Hard Learning Objective 1: 8.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.4 Solution: The all-events test is met when it is established that a liability exists, the amount is determined with reasonable accuracy, and economic performance has occurred. Economic performance occurs when the taxpayer receives services or property or uses property another party provided.

The law does not permit a deduction until the taxpayer has performed what has been promised under the contract.

Time on Task: 3 minutes 10

5) Title: Brief Exercise 5 Difficulty: Hard Learning Objective 1: 8.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.5 Solution: The de minimis safe harbor applies if the taxpayer does all the following: • Has written procedures in place at the beginning of the tax year that provide for the expensing of amounts below a specified dollar amount or that have a useful life of 12 months or less; • Also expenses the items for its accounting/book records; and • Ensures that items costing more than $5,000 are capitalized ($2,500 if the company does not have applicable financial statements—generally meaning audited financial statements).

A taxpayer cannot make the de minimis safe harbor election for inventory, land, and certain types of spare parts.

Time on Task: 4 minutes 6) Title: Brief Exercise 6 Difficulty: Hard Learning Objective 1: 8.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.6 Solution: UNICAP rules apply to realty and tangible personalty produced by the taxpayer or acquired by the taxpayer for resale. Examples of costs that can be capitalized and not capitalized are: Capitalized Direct material costs Direct labor costs Indirect costs including: • Indirect labor costs • Employee benefit expenses • Indirect material costs • Indirect purchasing and handling costs • Storage costs, rent, taxes insurance, utilities • Depreciation 11

Not Capitalized Mixed service and indirect costs including: • Marketing • Selling • Advertising • Income taxes • Tax services • Distribution • Research and experimental • Warranty

• Engineering and design costs • Tools and equipment • Interest, licensing, and franchise costs Time on Task: 5 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium Learning Objective 1: 8.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.1 Solution: a. The purchase of a dishwasher for your kitchen is a personal expense and not deductible. b. A license fee for a restaurant owner is a business expense and deductible. c. Investment journals purchased by a construction worker are an investment expense and not deductible. d. A newspaper ad for an estate sale is a personal expense and is not deductible. e. A online ad for your solely owned ice cream shop is a business expense and deductible. f. A subscription to The Journal of Investing is an investment expense and not deductible.

Time on Task: 4 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 8.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.1 Solution: The 2023 Schedule C is used because the 2024 Schedule C was not available at the time of publication. [[CODERS: Use high-res PDF file submitted: "Carnes_I2025_Ch08_SM_AP_2_Form 1040 Sch C 2023 Graham.pdf"]]

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Time on Task: 8 minutes 3) 13

Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 8.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.1 Solution: The 2023 Schedule E is used because the 2024 Schedule E was not available at the time of publication. [[CODERS: Use high-res PDF file submitted: "Carnes_I2025_Ch08_SM_AP_3_Form 1040 Sch E 2023 Taquia.pdf"]]

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Time on Task: 8 minutes 4) 15

Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 8.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.1 Solution: All of the expenses are considered personal and not deductible except for the commissions paid for trading stock. The commission is an investment expense that is added to the stock’s purchase price to compute his total basis in the shares. The basis is then deducted from the proceeds at the time of the sale when determining the taxable amount.

Time on Task: 3 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 8.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.2 Solution: The painting and brochures expenses are deductible in full for the current year. The display tables and the security system are considered capital expenditures and must be depreciated over their useful life which extends beyond one year.

Time on Task: 3 minutes 6) Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 8.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.2 Solution: a. Hal would be able to deduct all the business expenses against the revenue. Although the business has an illegal component, he can still deduct his business expenses. b. Hal would only be able to deduct the cost of goods sold for a drug trafficking business against revenue. The rest of the expenses are not deductible for this type of illegal activity.

Time on Task: 4 minutes 7) Title: Application Problem 7 16

Difficulty: Medium Learning Objective 1: 8.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.2 Solution: Greenfree cannot deduct the life insurance premiums paid for Carissa. No expenses can be deducted if the expense is used to generate tax-exempt income. Because Greenfree is the beneficiary of the life insurance policy, it cannot deduct the premiums paid on that policy.

Time on Task: 3 minutes 8) Title: Application Problem 8 Difficulty: Medium Learning Objective 1: 8.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.2 Solution: Nico cannot deduct the payments because Nico did not make the payments. Nico’s dad cannot deduct the payments because it is not his financial obligation, so he does not benefit from the payments.

Time on Task: 3 minutes 9) Title: Application Problem 9 Difficulty: Medium Learning Objective 1: 8.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.2 Solution: DaShawn may deduct $480 ($800  60%). The loan proceeds were used to produce taxable and tax-exempt income. Only the interest expense on the loan used to produce taxable income is deductible.

Time on Task: 4 minutes 10) Title: Application Problem 10 Difficulty: Medium Learning Objective 1: 8.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting 17

Standard 3: Bloom's || Application Section Reference 1: 8.2 Solution: BeSafe Company has taxable income of $201,900.

Revenue Less: Advertising Compensation Rent Utilities Depreciation Travel Taxable income

$575,000 ( 12,000) (250,000) ( 36,000) ( 24,000) ( 50,000) ( 1,100) ($2,000  55%) $201,900

The travel is deductible only to the extent the expenses can be substantiated. The entertainment, fines, premiums paid on key officers' life insurance, and bribes are not deductible expenses.

Time on Task: 6 minutes 11) Title: Application Problem 11 Difficulty: Medium Learning Objective 1: 8.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 8.3 Solution: a. State income tax—Itemized deduction (from AGI) b. Charitable contributions—Itemized deduction (from AGI) c. Student loan interest expense —Deduction for AGI d. Sales tax—Itemized deduction (from AGI) e. IRA contribution deduction—Deduction for AGI f. Educator expense—Deduction for AGI g. Real estate taxes for a vacation home—Itemized deduction (from AGI) h. Gambling loss—Itemized deduction (from AGI) i. Health savings account deduction—Deduction for AGI Time on Task: 5 minutes 12) Title: Application Problem 12 Difficulty: Hard Learning Objective 1: 8.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application 18

Section Reference 1: 8.4 Solution: a. Dirty Company can deduct the $9,900 insurance premium in 2024 because the benefit has a duration of only 12 months and doesn’t extend beyond 2025. b. No deduction is allowed in 2024. Dirty Company must capitalize the insurance premium and amortize and deduct $9,075 (11/12  $9,900) in 2025 and $825 (1/12  $9,900) in 2026. The benefit has a duration of only 12 months, but this benefit extends beyond 2025. c. No deduction is allowed in 2024. Dirty Company must capitalize the $9,900 insurance premium and can amortize and deduct $3,300 (1/3  $9,900) of the cost in 2025, 2026, and 2027.

Time on Task: 6 minutes 13) Title: Application Problem 13 Difficulty: Hard Learning Objective 1: 8.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.4 Solution: Prepaid interest must be capitalized and deducted in the future year or years for which the interest is actually charged. Pablo Company can deduct only $1,067 ($6,400/12 months  2 months for November and December). The remaining $5,333 is deductible in the following year.

Time on Task: 5 minutes 14) Title: Application Problem 14 Difficulty: Hard Learning Objective 1: 8.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.4 Solution: In order for the expense to be deductible, the liability must be fixed, the amount must be determinable with reasonable accuracy, and economic performance with respect to the liability must have occurred. BlueJay’s liability is fixed, the amount has been determined with reasonable accuracy, and the temporary employees have already performed the services in December. So, BlueJay can deduct the $45,000 on the current tax return.

Time on Task: 4 minutes 15) Title: Application Problem 15 Difficulty: Hard 19

Learning Objective 1: 8.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.4 Solution: a. Economic performance with respect to SafeNow’s liability for future service calls doesn’t occur until SafeNow provides the service. Consequently, SafeNow can’t deduct any of the $27,800 accrued expense in 2024. In 2025, it can deduct the $17,500 cost of the service calls provided in 2025 for 2024 systems purchased (350 service calls  $50 cost per call). The remaining 206 service calls (556 calls accrued – 350 calls serviced) will be addressed in 2025 and beyond. b. Under the recurring item exception, SafeNow can deduct $12,500 of the $27,800 accrued expense in 2024 (250 service calls made within 8½ months after the close of 2024  $50 cost per call). It can deduct $5,000 in 2025 (100 service calls made from September 16 through December 31  $50 cost per call). The remaining 206 service calls (556 calls accrued – 350 calls serviced) will be addressed in 2025 and beyond.

Time on Task: 8 minutes 16) Title: Application Problem 16 Difficulty: Medium Learning Objective 1: 8.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.4 Solution: a. GridIron Company can deduct $150,000 for the employee bonuses paid on February 14, 2025 on its 2024 tax return. The bonuses had been declared in 2024 and the liability was established and fixed. The $20,000 bonus paid to the 65% owner will be deductible in 2025 when the related party owner includes the bonus in income. b. Because the payments were not made within 2½ months after year-end, GridIron Company cannot deduct any of the payments until 2025.

Time on Task: 6 minutes 17) Title: Application Problem 17 Difficulty: Hard Learning Objective 1: 8.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.4 Solution: 20

For the current year, Buck must limit the deduction of the $35,000 for soil and water conservation expenditures to $31,250 ($125,000  25%).

Time on Task: 4 minutes 18) Title: Application Problem 18 Difficulty: Hard Learning Objective 1: 8.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.4 Solution: In this case, the farmer must limit her deduction for prepaid feed and seed to $9,000 (50% × $18,000). The law does not permit a deduction for advance payments for feed, seed, fertilizer, or other supplies to the extent such prepayments exceed 50% of total deductible farming expenses (excluding the prepaid items). The remaining $8,000 of prepaid expenses ($12,000 + $5,000 $9,000) will be deducted in the following year.

Time on Task: 4 minutes 19) Title: Application Problem 19 Difficulty: Medium Learning Objective 1: 8.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.5 Solution: The supplies, advertising, office expense, and shelving can be expensed. The shelving can be expensed because it is removable and not permanently affixed. The alarm system and display cases must be capitalized.

Time on Task: 4 minutes 20) Title: Application Problem 20 Difficulty: Medium Learning Objective 1: 8.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.6 Solution: Jermaine purchased $275,000 of inventory this year, but he must deduct the cost of inventory in the year sold if that is later than when he purchased it. You compute the amount of inventory sold as follows: 21

Beginning Inventory Plus: Purchases Inventory Available to Sale Less: Ending Inventory Inventory Sold During the Year

$165,000 275,000 $440,000 (135,000) $305,000

His expense for cost of goods sold is $305,000.

Time on Task: 6 minutes 21) Title: Application Problem 21 Difficulty: Hard Learning Objective 1: 8.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.6 Solution: BB can use the lower of cost or market method to value inventory if it is using FIFO, so the inventory is valued at $4,780,000 because that is lower than the market value. If BB is using LIFO, it must value the inventory at its cost of $4,780,000.

Time on Task: 4 minutes 22) Title: Application Problem 22 Difficulty: Medium Learning Objective 1: 8.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 8.6 Solution: a. Bones and Talus, Inc. may use the cash method of accounting because their average gross receipts are $30 million or less. b. Because Bones and Talus is a small business, it can deduct the cost of inventory in the year it is sold. Bones and Talus purchased $67,000 of inventory this year, but it cannot deduct this amount, even though it is a cash basis taxpayer. Rather, Bones and Talus must deduct the cost of inventory in the year sold if that is later than when it purchased it. You compute the amount of inventory sold as follows: Beginning Inventory Plus: Purchases Inventory Available for Sale Less: Ending Inventory Inventory Sold During the Year

$ 33,000 67,000 $100,000 (43,000) $ 57,000 22

The expense for cost of goods sold is thus $57,000. These are deductible as used or consumed with the amount left on hand at the end of the year recorded as an asset.

Time on Task: 6 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Difficult Learning Objective 1: 8.1 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 8.1 Solution: The three mutually exclusive categories for activities are personal, trade or business, and investment. Expenses related to the taxpayer’s personal activities are not deductible unless specifically allowed for by the IRC. Expenses related to a trade or business activity are deductible if they are related to the business operations and are ordinary, necessary, and reasonable. Expenses related to investment activities or other activities that produce income are deductible if ordinary, necessary, and reasonable.

To qualify as a trade or business, Trent needs to show that he has maintained detailed records for his inventory including his cost and acquisition date. He should also maintain a separate bank account, accounting records such as QuickBooks, and include his gross income and substantiated business expenses on Schedule C if he chooses to be a sole proprietor.

Time on Task: 8 minutes 2) Title: Tax Planning Problem 2 Difficulty: Difficult Learning Objective 1: 8.5 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 8.5 Solution: a. If the current year is 2024, Addison would be able to expense the paint immediately as a repair and deduct 60% of the remaining items through bonus depreciation. The remaining 40% of the assets must be capitalized and depreciated using MACRS. b. If the current year is 2025, Addison would be able to expense the paint immediately as a repair and deduct 40% of the remaining items through phased-out bonus depreciation.

The remaining 60% of the assets must be capitalized and depreciated using MACRS.

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c. If the current year is 2030, Addison would be able to expense the paint immediately as a repair. Bonus depreciation will no longer be available in 2030. He must capitalize the other items and depreciate them using MACRS. d. Year 2024 is the most advantageous because Addison would be able to deduct 60% of the expenses immediately.

Time on Task: 12 minutes Professional Development Skills Communications Problem 1) Title: Communication Problem Difficulty: Medium Learning Objective 1: 8.1,3 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 8.1,3 Solution: Memo to Client Hello Horatio, Thank you for allowing me to prepare your current year’s tax return. After reviewing your prior tax returns and list of expenses, I can explain what expenses are deductible.

As an employee for Dade County, you must report your wages received and reported on your W2. The $800 for uniforms and $750 spent on tools for the CSI position are not deductible.

Unreimbursed employee business expenses are not deductible. The income earned as a private investigator must be included in your taxable income. The $365 for the holster and $1,300 for office expenses for being a private investigator are deductible expenses on Schedule C to offset the revenue from Form 1099-MISC. The $1,000 for the display case for the guns and the $500 of special ammunition are not deductible because these are expenses from a personal activity.

Please let me know if you have any questions regarding your tax return.

Sincerely, Carnes & Youngberg, CPAs Tax memo to the file Facts: Horatio Kane works for Dade County as a CSI and receives a W-2. He also works as a private investigator and receives Form 1099-MISC and is a collector of valuable guns. Horatio provided a list of expense and wishes to take them as deductions on his tax return.

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$1,000 Display case for guns $ 500 Special ammunition for guns in the collection $ 800 Uniforms needed as a CSI $ 750 Tools for CSI position $ 365 Holster for a gun as a private investigator $1,300 Office expense related to being a private investigator Issue: Are the expenses provided deductible?

Conclusion: Only the expenses attributable to being a private investigator are deductible.

Analysis: The $800 for uniforms and $750 spent on tools for the CSI position are not deductible.

Unreimbursed employee business expenses are not deductible beginning January 1, 2018 due to the Tax Cuts and Jobs Act. The $1,000 for the display case for the guns and the $500 of special ammunition are not deductible, as these are expenses from a personal activity. The $365 for the holster and $1,300 for office expenses incurred for being a private investigator are deductible expenses on Schedule C under IRC §162.

Time on Task: 15 minutes Ethics Problem 1) Title: Ethics Problem Difficulty: Medium Learning Objective 1: 8.2 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 8.2 Solution: Under Statement on Standards for Tax Services No. 2.4.2, Use of Estimates, "unless prohibited by statute, administrative rule, or judicial holdings, a member may use estimates, whether from the taxpayer or other sources authorized by the taxpayer . . . if it not practical to obtain exact data and if the member determines that the estimates are reasonable based on the facts and circumstances known to the member." When records are missing or precise information about a transaction is not available at the time the return must be filed, a member may prepare a tax return using a taxpayer’s estimates of the missing data. A member may advise on estimates used in the preparation of a tax return, but the taxpayer has the responsibility to provide the estimated data.

The tax preparer would look at all information available including what is recoverable from this year and the accuracy of receipts from previous years in exercising due diligence.

Time on Task: 10 minutes Tax Compliance and Reporting Problem 25

1) Difficulty: Medium Learning Objective 1: 8.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 8.1 Solution: Schedule E Solution (The 2023 Schedule E is used since the 2024 Schedule E was not available at the time of publication.) [[CODERS: See submitted high-res PDF file: "Carnes_I2025_Ch08_SM_TaxCompliance_1_Form 1040 Sch E 2023 Urlacher.pdf"]]

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Time on Task: 15 minutes Research Problem 27

1) Title: Research Problem Difficulty: Medium Learning Objective 1: 8.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 8.2 Solution: Under IRC §280E, no deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act) which are prohibited

by Federal law or the law of any State in which such trade or business is conducted. Nonetheless, businesses subject to §280E may offset gross receipts by the cost of goods sold when determining their gross income under Treasury Regulation §1.61-3(a).

Although some states have relaxed their laws on distributing marijuana, marijuana is currently still a Schedule I controlled substance under the Federal Controlled Substances Act (CSA).

Therefore, MaryJane can only deduct her COGS and not her other operating expenses. Some have recently pushed to classify marijuana as a Schedule III controlled substance, which would allow marijuana businesses to deduct other operating expenses in addition to cost of goods sold.

However, as recently as August, 2021, in Sisley v. DEA lawsuit No. 20-71433 (9th Cir.), the Court of Appeals denied Sisley’s position that marijuana can be claimed as a Substance III controlled substance. The Drug Enforcement Agency (DEA) has a five-part test used to classify marijuana as a Schedule I drug, and the court ruled that Sisley did not exhaust their administrative remedies under the CSA and failed to provide sufficient argument that marijuana be considered a Schedule III drug to the DEA. Regarding MaryJane’s counseling services, when a taxpayer operates more than one trade or business, Section 280E does not apply to the businesses that are not trafficking in controlled substances. In Californians Helping to Alleviate Med. Problems, 128 T.C. at 173–86, the U.S. Tax Court found a taxpayer operating a community center for members with debilitating diseases was engaged in two separate trades or businesses for the purposes of §280E. However, in Olive, 139 T.C No. 2 at 41–42, the U.S. Tax Court ruled that the two businesses would not be considered separate if the only income being derived was from the sale of marijuana. Because MaryJane’s counseling services are operated as a separate business activity and generates income of its own, it is considered a separate business activity, and all the counseling business expenses are deductible.

Time on Task: 20 minutes CPA Exam Preparation: Task-Based Simulation 1) Difficulty: Medium 28

Learning Objective 1: 8.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 8.1 Solution: Schedule C, Profit or Loss from Business Line 1, 3, 5 and 7: Gross receipts = $12,000 Line 8: Advertising = $650 Line 22: Supplies = $890 Line 24b: Deductible meals = $215 ($430  50%) Line 25: Utilities = $1,200 Line 28: Total expenses = $2,955 Line 29 and 31: Profit = $9,045 Entertainment expenses are not deductible beginning January 1, 2018. Business meals are deductible at 50%.

Line Item Line 1 Line 2 Line 3 Line 4 Line 5 Line 6 Line 7 Line 8 Line 22 Line 24b Line 25 Line 28 Line 29 Line 30 Line 31

Description Gross receipts or sales Returns and allowances Subtract line 2 from line 1 Cost of Goods Sold Gross profit, subtract line 4 from line 3 Other income Total income Advertising Supplies Business Meals Utilities Total Expenses Tentative Profit Expenses for business use of your home Net profit or (loss)

Amount 12,000 0 12,000 0 12,000 0 12,000 650 890 215 1,200 2,955 9,045 0 9,045

[[CODERS: See submitted high-res PDF file: "Carnes_I2025_Ch08_SM_TBS_Form 1040 Sch C 2023 Monique James.pdf"]]

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Time on Task: 20 minutes 30

Chapter 9—Deductions for AGI and Itemized Deductions End-of-Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 9.1 Solution: Adjusted gross income (AGI) is the line that is referenced in the phrases “above the line” or “deduction for AGI” and “below the line” or “deduction from AGI.” Expenses are either deductible in calculating AGI (above the line) or reducing AGI to taxable income (below the line).

Time on Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 9.1 Solution: Adjusted gross income (AGI) is calculated by adding total gross income and subtracting deductions allowed for AGI. Time on Task: 2 minutes 3) Title: Discussion Question 3 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 9.1 Solution: The maximum student loan interest expense deduction that a taxpayer can deduct is $2,500. This is phased out for higher-income earners.

Time on Task: 1 minute

1

4) Title: Discussion Question 4 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Knowledge Section Reference 1: 9.1 Solution: An individual who would like to take an educator expense must teach Kindergarten through 12th grade. The maximum educator expense deduction is $300.

Time on Task: 1 minute 5) Title: Discussion Question 5 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Knowledge Section Reference 1: 9.1 Solution: No, only traditional IRA contributions are deductible for AGI. See Chapter 7, LO6, Retirement Plans.

Time on Task: 2 minutes 6) Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 9.1 Solution: To qualify, a taxpayer must have insurance coverage only under a high-deductible health plan and may not be entitled to benefits under Medicare. In 2024, a high-deductible health plan must have a deductible of at least $1,600 ($3,200 for family coverage) and annual out-of-pocket expenses cannot exceed $8,050 ($16,100 for family coverage).

Time on Task: 3 minutes 7) Title: Discussion Question 7 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Analytic 2

Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.1 Solution: If Ernie’s self-employment tax is $4,200, he can deduct $2,100 ($4,200  50%) as a deduction for AGI. 8) Title: Discussion Question 8 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 9.1 Solution: Self-employed taxpayers can deduct medical insurance premiums in calculating AGI. 100% of the medical insurance premiums (not exceeding self-employment income) paid by a selfemployed taxpayer for taxpayers (and spouse and dependents) who are not eligible to participate in an employer-subsidized health plan are deductible. The amount of the deduction cannot exceed the taxpayer’s self-employment income.

Time on Task: 2 minutes 9) Title: Discussion Question 9 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Knowledge Section Reference 1: 9.1 Solution: An alimony payment can be deductible in calculating AGI if the divorce decree was finalized before January 1, 2019. Alimony payments for divorces finalized after December 31, 2018 are not eligible for deduction.

Time on Task: 2 minutes 10) Title: Discussion Question 10 Difficulty: Easy Learning Objective 1: 9.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 9.2 Solution: 3

Taxpayers receive no benefit from their itemized deductions if their standard deduction is greater than their itemized deductions.

Time on Task: 3 minutes 11) Title: Discussion Question 11 Difficulty: Easy Learning Objective 1: 9.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Knowledge Section Reference 1: 9.3 Solution: The AGI threshold for medical expenses is 7.5%. The total of all medical expenses must exceed 7.5% of AGI before any benefit is received from the medical expenses.

Time on Task: 1 minute 12) Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 9.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.4 Solution: Sasha may not deduct both state income taxes and sales taxes, but rather the greater of the two.

Her sales tax deduction is $5,400.

Time on Task: 3 minutes 13) Title: Discussion Question 13 Difficulty: Medium Learning Objective 1: 9.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.4 Solution: Novak’s total for personal property tax of $750, real estate taxes of $7,500, and state income tax of $4,300 equals $12,550, but his deduction for state and local tax is limited to $10,000.

Time on Task: 3 minutes 14) Title: Discussion Question 14 Difficulty: Medium 4

Learning Objective 1: 9.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.5 Solution: Naomi can deduct investment interest expense to the extent of net investment income. Therefore, she can deduct $950 for an investment interest expense deduction. The remaining $250 is carried forward.

Time on Task: 3 minutes 15) Title: Discussion Question 15 Difficulty: Medium Learning Objective 1: 9.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.6 Solution: No, this is not a deductible charitable contribution. Although the person who is experiencing homelessness is in need, they are not a qualified organization under IRC §501(c)(3).

Time on Task: 2 minutes 16) Title: Discussion Question 16 Difficulty: Easy Learning Objective 1: 9.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 9.6 Solution: Up to 60% of AGI is deductible if a taxpayer gives cash contributions.

Time on Task: 1 minute 17) Title: Discussion Question 17 Difficulty: Easy Learning Objective 1: 9.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 9.7 Solution:

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A taxpayer can deduct a loss for a casualty that occurred in a federally declared disaster area.

The net loss after insurance reimbursement must exceed $100 plus 10% of AGI as well.

Time on Task: 2 minutes 18) Title: Discussion Question 18 Difficulty: Medium Learning Objective 1: 9.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.7 Solution: A casualty is a sudden, unexpected event that damages or destroys property. For a casualty loss to be deductible, it must be attributable to a federally declared disaster area. Termite damage is not considered sudden or unexpected but happens gradually over time. Also, it probably did not occur in a federally declared disaster area.

Time on Task: 3 minutes 19) Title: Discussion Question 19 Difficulty: Medium Learning Objective 1: 9.8 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.8 Solution: Tommy can deduct $13,450 of his gambling losses. Gambling losses can be deducted only to the extent of gambling winnings.

Time on Task: 2 minutes 20) Title: Discussion Question 20 Difficulty: Medium Learning Objective 1: 9.8 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.8 Solution: Jake cannot take a miscellaneous itemized deduction for the unreimbursed employee business expenses. Miscellaneous itemized deductions were eliminated by the Tax Cuts and Jobs Act effective January 1, 2018 through December 31, 2025.

Time on Task: 2 minutes

6

Multiple Choice Questions 1) Answer: a Title: Multiple Choice Question 1 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: The correct answer is $400.

Legal expenses related to a business are deductible if ordinary, necessary, and reasonable. The legal expenses paid for the will, divorce, and tax advice are personal expenses and not deductible.

Time on Task: 2 minutes 2) Answer: a Title: Multiple Choice Question 2 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 9.1 Solution: The correct answer is State income tax.

State income tax paid is an itemized deduction. Interest on student loans, subject to certain limitations, one-half of self-employment taxes paid, and attorney’s fees for discrimination lawsuits are deductible for AGI. Time on Task: 2 minutes 3) Answer: d Title: Multiple Choice Question 3 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: The correct answer is Child support payments paid to a former spouse.

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Child support is never deductible. Student loan interest expense, alimony paid on a divorce settlement before January 1, 2019, and educator expenses are all deductions for AGI. Time on Task: 2 minutes 4) Answer: c Title: Multiple Choice Question 4 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 9.1 Solution: The correct answer is Student loan interest.

Student loan interest expense is allowed as a deduction for AGI. Interest expense paid on a mortgage for a principal residence and one other residence is deductible as an itemized deduction. Investment interest expense, subject to certain limitations, is deductible as an itemized deduction. Interest paid on a home equity loan where the proceeds are used to substantially improve the residence is deductible as an itemized deduction.

Time on Task: 2 minutes 5) Answer: b Title: Multiple Choice Question 5 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Knowledge Section Reference 1: 9.1 Solution: The correct answer is $300.

A teacher who instructs K–12 grades can deduct up to $300 of unreimbursed educator expenses for AGI. Time on Task: 1 minute 6) Answer: c Title: Multiple Choice Question 6 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 8

Solution: The correct answer is $2,750.

Seth can take a deduction for AGI for one-half of self-employment tax paid ($5,500  50%).

Time on Task: 2 minutes 7) Answer: c Title: Multiple Choice Question 7 Difficulty: Easy Learning Objective 1: 9.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Knowledge Section Reference 1: 9.4 Solution: The correct answer is Fees paid to the local government for sidewalks to be installed in one’s neighborhood.

The fees paid are for a specific benefit, so they are not deductible. The rest are deductions for state and local taxes and are itemized deductions.

Time on Task: 2 minutes 8) Answer: a Title: Multiple Choice Question 8 Difficulty: Easy Learning Objective 1: 9.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.5 Solution: The correct answer is $0.

Interest expense paid on a home equity line is not deductible unless the proceeds are used for the substantial improvement of the home. Because the proceeds are used to purchase a boat, the interest is not deductible.

Time on Task: 3 minutes 9) Answer: c Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 9.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.6 9

Solution: The correct answer is $30,000.

Rodney can deduct the fair market value, limited to 30% of AGI, because this is long-term capital gain property. $100,000  30% = $30,000. The remaining $20,000 can be carried forward for up to five years.

Time on Task: 3 minutes 10) Answer: d Title: Multiple Choice Question 10 Difficulty: Medium Learning Objective 1: 9.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.6 Solution: The correct answer is Taxpayers may be able to deduct the fair market value of stock given to a qualified charitable organization.

If stock is held long-term, then the fair market value can be deducted. Charitable contributions disallowed due to the 50% of AGI limitation can be carried forward for five years only. A canceled check is not sufficient documentation for a cash contribution of $500 to a charity. You must also receive a receipt from the qualified organization. An attorney who provides free legal advice to a qualified charitable organization cannot deduct the fair market value of his services.

Services provided to a qualified charitable organization are not deductible.

Time on Task: 4 minutes 11) Answer: b Title: Multiple Choice Question 11 Difficulty: Easy Learning Objective 1: 9.8 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Knowledge Section Reference 1: 9.8 Solution: The correct answer is Gambling losses to the extent of gambling winnings.

Gambling losses to the extent of gambling winnings are deductible as another itemized deduction. The other expenses listed are not deductible.

Time on Task: 2 minutes 12) Answer: b Title: Multiple Choice Question 12 Difficulty: Easy 10

Learning Objective 1: 9.8 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Knowledge Section Reference 1: 9.8 Solution: The correct answer is Unreimbursed employee business expenses.

Unreimbursed employee business expenses are not a deductible itemized deduction.

Miscellaneous itemized deductions were eliminated by the Tax Cuts and Jobs Act effective January 1, 2018, through December 31, 2025. Medical expenses in excess of 7.5% of AGI are deductible as an itemized deduction. An IRA contribution is a deduction for AGI. Gambling losses are deductible to the extent of gambling winnings as another itemized deduction.

Time on Task: 2 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: Tori can deduct the $100 penalty on early withdrawal of savings when calculating AGI. Child support is never deductible; only alimony is deductible for a divorce finalized before 2019. The $425 payment to the dentist may be deductible as a medical expense if Tori itemizes her deductions. The medical expense is not deductible for AGI. The $1,000 moving expense is not deductible except for active members of the armed services who move pursuant to a military order.

Time on Task: 3 minutes 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 9.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.2 Solution: a. $32,300 ($29,200 + $1,550 age + $1,550 age) b. $14,600. Dimitri does not receive an additional standard deduction for being a person with quadriplegia.

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c. Tanner will have a standard deduction of $14,600. Tammy will have a standard deduction of $16,150 ($14,600 + $1,550 blind). d. $18,500 ($14,600 + $1,950 age + $1,950 blind) Time on Task: 4 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 9.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.3 Solution: Total medical expense payments that qualify for the medical expense deduction include: Doctor bill for dependent daughter, Berkley $1,600 Crutches for Emily 300 Dental bill for Emily 1,500 Prescription medication 600 Total $4,000 Emily can deduct $250 [$4,000 – $3,750 ($50,000 AGI  7.5%)] for medical expenses. The vet expenses for Bodhi and the health spa expenses do not qualify.

Time on Task: 4 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 9.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.3 Solution: Lina cannot deduct any of the payments made as a medical expense. Medical marijuana is not legal under federal law. Any drug that is not legal under federal law is not a qualified medical expense. Over-the-counter medication is not prescription medication and therefore, not deductible (except insulin). Cosmetic surgery for a facelift is an elective treatment and not needed for one’s physical or mental well-being. Maternity clothing is not deductible because it is not an expenditure for the care, prevention, cure, or treatment of disease or bodily function.

Time on Task: 4 minutes 5) 12

Title: Brief Exercise 5 Difficulty: Medium Learning Objective 1: 9.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.4 Solution: Aditi’s state and local tax deduction is $10,000. She can deduct her state and local sales tax of $6,560 ($3,200 + $800 + $2,560) which is greater than her state income tax of $6,000 ($4,000 + $2,000). She can also deduct her real estate taxes of $5,000 for total taxes paid of $11,560 ($6,560 + $5,000). However, she is limited to a $10,000 deduction for state and local taxes paid.

Time on Task: 4 minutes 6) Title: Brief Exercise 6 Difficulty: Medium Learning Objective 1: 9.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.5 Solution: Beginning in 2022, premiums paid for qualified mortgage insurance are not deductible.

Time on Task: 2 minutes 7) Title: Brief Exercise 7 Difficulty: Hard Learning Objective 1: 9.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.6 Solution: If Peng sold the equipment, the total gain would be $16,000 ($28,000 amount realized − $12,000 adjusted basis), of which he would recapture $6,500 as ordinary income. If Peng contributed this property to a qualified charitable organization, the deduction would be $21,500 ($28,000 − $6,500).

Time on Task: 4 minutes 8) Title: Brief Exercise 8 Difficulty: Medium Learning Objective 1: 9.6 Standard 1: AACSB || Analytic 13

Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.6 Solution: If Ima had sold the land, she would have a short-term capital loss of $9,000 ($36,000 amount realized − $45,000 adjusted basis). The tax law limits her deduction to the FMV of $36,000.

Time on Task: 4 minutes 9) Title: Brief Exercise 9 Difficulty: Medium Learning Objective 1: 9.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.7 Solution: None of the events are qualifying events to allow a casualty loss deduction.

Time on Task: 3 minutes 10) Title: Brief Exercise 10 Difficulty: Easy Learning Objective 1: 9.8 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.8 Solution: Vladimir cannot deduct hobby expenses.

Time on Task: 2 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: a. Denka can deduct the maximum of $2,500 because her AGI is below $75,000. b. Denka can deduct $2,167 [$2,500 − ($2,500  ($82,000 − $80,000)/$15,000)] 14

c. Denka cannot deduct any of the $4,650 because her AGI is above $95,000.

Time on Task: 6 minutes 2) Title: Application Problem 2 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: Mary Kate can deduct $300 for an Educator expense. She teaches K-12 and was not reimbursed by her school for these supplies.

Time on Task: 2 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: Because Ruby does not participate in another qualified plan, there is no phaseout range, and she may deduct $7,000 for a traditional IRA. For a Roth IRA, she can contribute $7,000, but she is not allowed a deduction.

Time on Task: 3 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: Qualified taxpayers can contribute funds to a health savings account and receive a deduction for AGI in the year the contribution is made (or until April 15 of the following year), unless the taxpayer has used pre-tax dollars withheld by their employer to fund the HSA. If the individual directs his employer to allocate a portion of his earnings to the HSA, the employer does not include this amount as wages on the employee’s W-2. Because Amy's employer used pre-tax dollars to make the $6,000 contribution to the Health Savings Account, Russ and Amy may not 15

deduct the $6,000 contribution on their joint Federal Income Tax Return. In 2024, the annual contribution is limited to $8,300 for families. Distributions must be used exclusively for qualified medical expenses and are not included in income. Non-qualified distributions are included in gross income and are subject to a 20% penalty. Amy and Russ contributed $6,000 and the distributions totaled $6,000; however, $1,000 was used for a Psychic hotline which is not a qualifying medical expense. Therefore, Amy and Russ must include the $1,000 in income and are subject to a penalty of $200 ($1,000  20%).

Time on Task: 5 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: Moving Expenses are no longer deductible, except for active members of the armed services who move pursuant to a military order. The tax law limits qualified moving expenses to the cost of moving all possessions from the old residence to the new residence and the cost of the taxpayer and the taxpayer's family traveling to the new location. Lodging is not deductible during the travel. Therefore, Kevin can deduct $1,200 for moving his possessions and the $450 airfare for a total of $1,650. He cannot deduct the meals or hotel room charge. The $1,650 is a deduction for AGI. Time on Task: 4 minutes 6) Title: Application Problem 6 Difficulty: Easy Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: Elisa paid $14,200 in self-employment tax and she is entitled to a self-employment tax deduction of $7,100 ($14,200  50%). The deduction is for AGI and reported on Schedule 1.

Time on Task: 3 minutes 7) Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting 16

Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: a. Because Terry’s self-employment income is $100,000, he can deduct the employee health insurance of $9,000 on Schedule C and the $12,000 on Schedule 1, Part II for himself and his family. b. Because Terry’s self-employment income is only $18,500, his health insurance deduction is limited. His self-employment income after deducting the health insurance premiums for the employees of $9,000 on Schedule C is $9,500. Therefore, the deduction for his health insurance premium for AGI on Schedule 1, Part II is limited to his self-employment income before his deduction of $9,500.

Time on Task: 6 minutes 8) Title: Application Problem 8 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: a. Child support is never deductible, nor are transfers of property pursuant to a divorce. If the divorce was finalized after 2018, then the $36,000 of alimony paid is also not deductible. b. Child support is never deductible, nor are transfers of property pursuant to a divorce. Because the divorce was finalized prior to 2019, the $36,000 of alimony paid in the current year is deductible.

Time on Task 4 minutes 9) Title: Application Problem 9 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: Zorida must include the $500 as income, but she also may take a deduction of $500 in calculating AGI because she had to turn it over to her employer.

Time on Task: 3 minutes 10) Title: Application Problem 10 17

Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: Angel’s AGI is computed as follows: Wages $55,000 Less: Alimony (12,000) Penalty ( 250) Educator exp. ( 300) Interest on student loans ( 1,800) AGI $40,650 Angel’s contribution to a Roth IRA is not deductible. The educator expenses are limited to $300 for educators who teach Kindergarten through 12th grade. The cash charitable contribution is not deductible for AGI. Time on Task: 5 minutes 11) Title: Application Problem 11 Difficulty: Hard Learning Objective 1: 9.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.1 Solution: Diante’s AGI is computed as follows: Wages Discrimination award Self-employment income Interest income Total income Less: Attorney fees IRA contribution SE tax deduction AGI

$ 20,000 20,000 29,725 500 $ 70,225 ( 800) ( 7,000) ( 2,100) $ 60,325

The alimony paid is not deductible because it is from an agreement after 2018. The tuition and fees are not deductible. Diante may be eligible for the American Opportunity Tax Credit or the Lifetime Learning Credit (see Chapter 16, LO6, Education Tax Credits), but credits do not affect 18

AGI. The self-employment tax deduction is allowable for 50% of the self-employment tax paid ($4,200  50%). The attorney fees paid of $800 are fully deductible because they relate to a discrimination case and the award received and included in income is in excess of $800.

Time on Task: 6 minutes 12) Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 9.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.2 Solution: Carson’s total standard deduction is $18,500 ($14,600 basic + $1,950 age + $1,950 blind).

Because his itemized deductions of $15,000 are less than his standard deduction, Carson will deduct the standard deduction of $18,500.

Time on Task: 2 minutes 13) Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 9.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.3 Solution: Fanny’s total allowable medical expenses are as follows: Physician charges Hospital charges Prescription medicine Contact lenses Total

$ 3,000 12,000 750 600 $16,350

Fanny’s deductible medical expenses are $16,350 − $7,000 reimbursement − $4,125 (7.5% of AGI) = $5,225. The non-prescription medicine (not insulin), medical marijuana (not an expense allowed under federal law), and massage club membership are not deductible.

Time on Task: 5 minutes 14) Title: Application Problem 14 Difficulty: Medium Learning Objective 1: 9.3 Standard 1: AACSB || Analytic 19

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 9.3 Solution: The tax law treats both Christian’s mom and niece as dependents for purposes of deducting medical expenses because the only reason the niece is not a dependent is that she failed the gross income test. Therefore, Christian’s total allowable medical expense is $11,700 ($6,200 + $4,000 + $1,500). His deductible medical expense is $4,200 [$11,700 − ($100,000  7.5%)].

Time on Task: 3 minutes 15) Title: Application Problem 15 Difficulty: Hard Learning Objective 1: 9.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.3 Solution: a. If the pool would help with weight loss and her general health but does not have a specific medical purpose, then the cost is not deductible. b. If the pool will help her son with disabilities with physical therapy, is the only form of exercise prescribed by his doctor in a written plan, and there is no other pool within a close driving distance, then the expense will be allowable to the extent the cost exceeded the increase in the fair market value of the home, $5,000 [$25,000 – ($340,000 – $320,000)]. The $5,000 is added to her other qualified medical expenses for the year, and the total is reduced by $3,750 ($50,000  7.5%). Her deductible medical expense for the pool is $1,250 ($5,000 – $3,750).

Time on Task: 6 minutes 16) Title: Application Problem 16 Difficulty: Medium Learning Objective 1: 9.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.4 Solution: Tiffany can deduct $2,700 ($1,200 + $1,000 + $500). She can deduct all state and local taxes paid in Year 4. The federal income taxes withheld are not deductible. The Year 4 state income taxes paid in Year 5 are not deductible until Year 5.

Time on Task: 3 minutes 17) Title: Application Problem 17 20

Difficulty: Medium Learning Objective 1: 9.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.4 Solution: Elias’s total state and local tax expenses are $13,500 ($4,400 + $5,200 + $3,300 + $600), but he is limited to $10,000. Elias deducts the greater of sales tax ($4,400) or state income tax ($3,900) in this total ($4,400). The vehicle license fee is not deductible. The personal property tax is deductible because it is based on the value of the vehicle.

Time on Task: 4 minutes 18) Title: Application Problem 18 Difficulty: Medium Learning Objective 1: 9.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.4 Solution: Daphne can deduct state and local taxes of $9,000. She can deduct her total sales tax of $3,500 ($1,800 + $600 + $1,100) which is greater than her state income tax of $3,300. She can also deduct her real estate taxes paid for property in Texas of $5,500. Daphne cannot deduct the federal income tax, gift tax, or real estate taxes paid for property in Canada.

Time on Task: 4 minutes 19) Title: Application Problem 19 Difficulty: Medium Learning Objective 1: 9.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.5 Solution: Interest is deductible on only $750,000 of acquisition debt because the debts were taken out after December 15, 2017. Interest on home equity debt is not deductible unless the loan was used to substantially improve the residence. The debt from both residences totaled $940,000 and the total interest expense paid on both residences is $32,960.

The interest must be pro-rated because only the interest on $750,000 of debt is deductible: $750,000 × $32,960 = $26,298 deductible $940,000 21

Time on Task: 4 minutes 20) Title: Application Problem 20 Difficulty: Medium Learning Objective 1: 9.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.5 Solution: Celia may deduct the mortgage interest expense of $8,800 and the points of $2,400. Mortgage insurance premiums are not deductible. Celia’s total deductions are $11,200 ($8,800 + $2,400).

Time on Task: 5 minutes 21) Title: Application Problem 21 Difficulty: Medium Learning Objective 1: 9.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.5 Solution: Darnell can deduct $10,700 ($8,200 + $2,500 (limited to net investment income)). Credit card interest expense is not deductible. Student loan interest expense is deductible as a deduction for AGI but not as an itemized deduction.

Time on Task: 6 minutes 22) Title: Application Problem 22 Difficulty: Medium Learning Objective 1: 9.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.5 Solution: a. Reed’s net investment income is $12,000. The qualified dividend income is not included in net investment income unless Reed elects to do so. The investment counseling fee is not deductible so it cannot reduce net investment income. Reed’s deduction for investment interest expense is $12,000 and he can carry forward the remaining $6,000 indefinitely. b. Reed can elect to include a portion of the qualified dividend income in the determination of the investment interest expense limitation. If Reed elects to treat $6,000 of the qualified dividend income as investment income, all $18,000 of his investment interest expense will be deductible.

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But by doing this, $6,000 of the qualified dividend income will be taxed at 37%, leaving only the remaining $4,000 of qualified dividend income to be taxed at the LTCG preferential rate of 20%.

Time on Task: 6 minutes 23) Title: Application Problem 23 Difficulty: Medium Learning Objective 1: 9.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.6 Solution: The money given to the man experiencing homelessness, her niece, and her mom are all considered gifts but not to a qualified charitable organization, so they are not deductible. The blood donated is a nondeductible item, but the clothing is deductible at FMV. Aya spent $500 on qualifying expenses for the foreign exchange student, but she is limited to $250 ($50 allowed for five months living in her home). Aya has charitable contributions of $8,250 ($2,500 + $1,000 + $500 + $2,200 + $1,800 + $250). Her deduction is also $8,250 because she has not exceeded her AGI limitations for these contributions.

Time on Task: 6 minutes 24) Title: Application Problem 24 Difficulty: Medium Learning Objective 1: 9.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.6 Solution: If Maverick sold the stock, he would have a LTCG of $25,000 ($67,000 − $42,000). Therefore, he has an allowable contribution of $67,000 (FMV) as a charitable contribution. However, in the current year, his deduction is limited to 30% of $175,000, or $52,500. The remaining $14,500 of the contribution can be carried forward for the next five years.

Time on Task: 5 minutes 25) Title: Application Problem 25 Difficulty: Medium Learning Objective 1: 9.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.6 Solution: 23

a. The property is LTCG property, so the general rule is that Bekah can deduct the FMV of $21,000. The tax law limits the current year deduction to 30% of AGI, or $30,000 ($100,000  30%). Because the FMV is less than the limit, Bekah can deduct the FMV of $21,000. b. The library sold the book collection and did not use it in a manner consistent with its taxexempt purposes. Therefore, her deduction is limited to $12,000, the adjusted basis of the property.

Time on Task: 6 minutes 26) Title: Application Problem 26 Difficulty: Medium Learning Objective 1: 9.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.6 Solution: Dillion can only deduct contributions that he can substantiate. He can deduct the $4,000 of contributions that are substantiated. He cannot deduct the contribution to the Salvation Army Red Kettle, because it is not substantiated. He can deduct $465 donated to the Chicago Symphony Orchestra, because he has to reduce his $500 contribution for the $35 property value he received in return. Dillion cannot take a deduction for his services provided to his church parishioners. Therefore, Dillion can deduct a total of $4,465 in charitable contributions.

Time on Task: 4 minutes 27) Title: Application Problem 27 Difficulty: Hard Learning Objective 1: 9.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.6 Solution: a. Zimena’s church is a public charity, so her contributions to the church are subject to the 50%/60%/30%-capital gain limitations. These contributions total $50,000, $5,000 for the cash and $45,000 for the stock. To determine the allowable deduction for her charitable contributions, we must consider the following steps: Step 1: Her $5,000 cash contribution is far below its maximum limitation of $45,000 (60%  $75,000).

Step 2: Her total contributions to public charities ($50,000) are more than the maximum amount allowed of $37,500 (50% of $75,000). The $5,000 cash donated to the church is deducted first and is deductible in full because it is less than 60% of AGI.

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Step 3: Her $6,000 contribution to the private foundation comes next in the ordering rules because it is a 30% charity. However, the $6,000 is not deductible this year because the overall limitation of $37,500 ($75,000  50%) has already been met as explained above.

Step 4: The donation for the gift of stock can be deducted up to $32,500 for the 50% limitation ($37,500 – $5,000), but now the 30% limitation for LTCG property must be applied also. The deduction for the contribution of the stock is limited to $22,500 (30%  $75,000).

Step 5: Not applicable Thus, Zimena may deduct only $27,500 ($5,000 + $22,500). The unused portion of the stock contribution ($22,500 [$45,000 − $22,500]) and the gift to the private foundation ($6,000) are carried over to the next year, still subject to their respective 30% limitations. b. Zimena could deduct the $5,000 cash contribution and the stock’s adjusted basis of $28,000.

The law limits her overall deduction to 50% of AGI ($37,500) so she can deduct $4,500 of her contribution to the private foundation. Her current deduction would thus be $37,500 ($5,000 cash + $28,000 land + $4,500 cash to private foundation).

The remaining $1,500 cash to the private foundation would be carried over to the next year. For the gift of cash to the private foundation, the 30% of AGI limit applies rather than the 60% of AGI limit. The 60% of AGI limit applies only for gifts of cash to charities that qualify as 50% of AGI charities. Private foundations are not 50% charities.

Time on Task: 10 minutes 28) Title: Application Problem 28 Difficulty: Medium Learning Objective 1: 9.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.7 Solution: The casualty loss deduction is $54,900.

Lower of decline in FMV ($120,000) or Adjusted basis of property [$200,000] Less: Insurance Reimbursements Less: $100 per casualty Less: 10%  AGI ($150,000) Casualty loss Time on Task: 6 minutes 29) Title: Application Problem 29 Difficulty: Hard 25

$120,000 ( 50,000) ( 100) ( 15,000) $ 54,900

Learning Objective 1: 9.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Evaluation Section Reference 1: 9.7 Solution: The hurricane occurred in a federal disaster area and therefore, it is considered a casualty. Sandra has a casualty gain from the North Carolina home of $15,000 because her insurance reimbursement of $200,000 was in excess of the asset’s adjusted basis ($185,000). Her casualty loss from the theft of the necklace is $9,900 ($10,000 FMV − $100). Her gain may be reduced by the theft of her diamond necklace, thereby reducing her casualty gain to $5,100 [$15,000 − $9,900]. Casualty losses that are not from a federally declared disaster can reduce casualty gains, but not below zero. The breakage of the expensive vase does not qualify as a casualty and does not reduce the casualty gain.

Time on Task: 8 minutes 30) Title: Application Problem 30 Difficulty: Medium Learning Objective 1: 9.8 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.8 Solution: a. If Yasmine is an amateur, then she can deduct gambling losses only to the extent of gambling winnings. Therefore, Yasmine can deduct a gambling loss itemized deduction of $14,000. b. If Yasmine is a professional gambler, then she can deduct her gambling losses on Schedule C to the extent of her gambling winnings: Income $14,000 Less: Betting tickets ( 14,000) Net loss ($ 0 Time on Task: 6 minutes 31) Title: Application Problem 31 Difficulty: Easy Learning Objective 1: 9.8 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Application Section Reference 1: 9.8 Solution:

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Indra cannot deduct any of the expenses as itemized deductions. They are all miscellaneous itemized deductions that are no longer deductible beginning in 2018 through December 31, 2025.

Time on Task: 2 minutes 32) Title: Application Problem 32 Difficulty: Medium Learning Objective 1: 9.1 Learning Objective 2: 9.2 Learning Objective 3: 9.3 Learning Objective 4: 9.4 Learning Objective 5: 9.5 Learning Objective 6: 9.6 Learning Objective 7: 9.7 Learning Objective 8: 9.8 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom’s || Knowledge Section Reference 1: 9.8 Solution: ▪ One half of self-employment tax—For AGI ▪ Mortgage interest expense on principal residence—From AGI ▪ Traditional IRA contribution—For AGI ▪ Penalty for early withdrawal from CD—For AGI ▪ Medical expenses—From AGI ▪ Charitable contributions—From AGI ▪ Casualty expense in federally declared disaster area—From AGI ▪ Student loan interest expense—For AGI ▪ Educator expense—For AGI ▪ Roth IRA contribution—Neither Time on Task: 5 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Hard Learning Objective 1: 9.2 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 9.2 Solution: The basic standard deduction for married filing separately is $14,600. Jesse can add $1,550 to this amount because he is age 75 for a total standard deduction of $16,150. Edith has two additional standard deductions for being age 72 and blind, for a total standard deduction of 27

$17,700 ($14,600 + $3,100). Jesse and Edith must both itemize, or both use the standard deduction, so their options are as follows:

Standard Deduction

Jesse $16,150

Edith $17,700

Total $33,850

Itemized Deductions

$12,000

$22,000

$34,000

Even though Jesse has less itemized deductions than his standard deduction, it is still better for the couple overall to itemize their deductions.

Time on Task: 8 minutes 2) Title: Tax Planning Problem 2 Difficulty: Hard Learning Objective 1: 9.5 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 9.5 Solution: Reba’s net investment income is $7,200 ($4,200 + $3,000). Her deduction for investment interest expense is $7,200 and she can carry forward the remaining $1,800 indefinitely. Reba can elect to include a portion of the net LTCG in the determination of the investment interest expense limitation. If Reba elects to treat $1,800 of the net LTCG as investment income, all the taxpayer's investment interest expense will be deductible. But by doing this, $1,800 of the net LTCG is taxed at ordinary tax rates, leaving only the remaining $3,000 of net LTCG to be taxed at preferential rates.

It would not be a smart decision for Reba to make the election in the current tax year. By doing so, she increases the tax rate on the $1,800 of LTCG from 15% to 24%, which means she would pay an extra $162 in taxes ((24% − 15%)  $1,800). If she does not make the election, she will be able to deduct the $1,800 of investment interest next year because she anticipates sufficient investment income to do so. Deducting the additional $1,800 of investment interest one year earlier is not worth paying an additional $162 in tax.

Time on Task: 8 minutes 3) Title: Tax Planning Problem 3 Difficulty: Hard Learning Objective 1: 9.6 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 9.6 Solution: 28

Because the standard deduction is $29,200 for married filing joint in 2024, Roger and Mirka would lose the benefit of their itemized deductions of $24,250 ($10,000 SALT deduction + $8,250 mortgage interest expense + $6,000 charitable contribution) because they are less than the standard deduction. The medical expenses do not exceed 7.5% of AGI so no deduction is allowed. By grouping their charitable contributions into 2024 and adding an additional $6,000, the new total itemized deductions would be $30,250 which is in excess of the standard deduction. They should make the additional charitable contribution and itemize their deductions in 2024, and then use the standard deduction in 2025. This maximizes the total deduction in 2024 and 2025 combined.

Time on Task: 6 minutes Communication Problem 1) Title: Communication Problem: Unreimbursed Employee Business Expenses Difficulty: Medium Learning Objective 1: 9.8 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 9.8 Solution: Memo to Client Dear Chuck, Congratulations on the new job! It sounds very challenging and rewarding. You have asked about the deductibility of your unreimbursed employee business expenses. I wish I had better news, but none of your expenses are deductible. Beginning in January 2018 through December 31, 2025, unreimbursed employee business expenses are not deductible as itemized deductions.

You should ask your employer if they have any type of reimbursement plan for substantiated expenses of these types.

Your employer can still deduct all qualified employee expense reimbursements. If your employer decides to reimburse your expenses, make sure they use an “accountable plan” that meets all IRS requirements. Using an accountable plan allows your employer to deduct reimbursed expenses and not include the reimbursed amount in your wages on Form W-2. If your employer does not use an accountable plan, any reimbursements must be included on your Form W-2 as taxable income.

Sorry I could not give you better news. Please let me know if you have any further questions.

Sincerely, Carnes & Youngberg, CPAs

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Tax memo to the file Facts: Chuck has recently been employed as a construction worker and purchased boots and clothing appropriate for outdoor work. The boots and clothing would only be worn at work. His foreman mentioned that the company will not reimburse Chuck for the money spent.

Issue: Is the $1,575 spent on employee business expenses deductible by Chuck?

Conclusion: No, Chuck may not deduct unreimbursed employee business expenses.

Analysis: Beginning in January 2018 through December 31, 2025, unreimbursed employee business expenses are not deductible. Prior to 2018, these types of expenses were allowed as a miscellaneous itemized deduction subject to the 2% of AGI floor under IRC §67. It would be best if the employer provides reimbursement under an accountable plan. This would allow the employee reimbursement without having to include it in income for Chuck and the business is allowed a deduction.

Time on Task: 15 minutes Ethics Problem 1) Title: Ethics Problem: Overstated Charitable Contribution Difficulty: Hard Learning Objective 1: 9.6 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 9.6 Solution: a. SSTS No. 1.2.2 and 1.2.16 are not applicable to an item that has an insignificant effect on the taxpayer’s tax liability. Circular 230, §10.21 does not contain an exception for an insignificant effect. Thus, Circular 230, §10.21 requires the practitioner to advise the client of the facts and consequences of the error. b. Both SSTS No. 1.2 and Circular 230, §10.21 require the member to inform the taxpayer of the error and the consequences of such error. It is the taxpayer’s responsibility to decide whether to correct or disclose an error. Under SSTS No. 1.2.7, if the taxpayer does not correct or disclose an error, you should consider whether to withdraw from the engagement and whether to continue a professional or employment relationship with the taxpayer. You should consider your responsibility under Circular 230 §10.34(b)(iii) regarding the submission of a document that contains information that may be considered an intentional disregard of a rule or regulation. You also have the responsibility under §10.34(c) to inform the client regarding potential penalties that may apply and the possible opportunity to avoid such penalties by disclosure of the error.

Finally, Circular 230, §10.51(a) defines incompetence and disreputable conduct for which a practitioner may be sanctioned. This needs careful consideration as well.

Time on Task: 10 minutes 30

Research Problem 1) Title: Research Problem: Medical Expense Deduction Difficulty: Hard Learning Objective 1: 9.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 9.3 Solution: a.

Air conditioning $10,000 Prescription drugs 1,000 Doctor expenses 2,000 Health insurance 4,500 Total medical $17,500 Less: 7.5% of AGI ( 7,125) Allowable medical $10,375 Capital expenditures are deductible only to the extent that the cost exceeds the increase in the property’s fair market value because of the capital expenditure. The fair market value of the home increased by $6,000 as a result of the installation and, therefore, the cost of the air conditioner is reduced by $6,000 to arrive at the allowable amount. To secure a current medical expense deduction for a capital expenditure, the cost must be reasonable in amount and incurred out of medical necessity for primary use by the individual requiring medical care. Reg. §1.2131(e)(1)(iii). b. Brenda’s medical expense deduction would increase by $1,800 ($150  12 months). Costs incurred to operate or maintain the capital expenditure (such as increased utility expenses and maintenance costs to operate the elevator as illustrated in both examples) are deductible currently as medical expenses as long as the medical reason for the expenditures continues to exist. Rev. Rul. 87-106, 1987-2 C.B.67.

Time on Task: 15 minutes Tax Compliance and Reporting Problem 1) Title: Tax Compliance and Reporting Problem: Schedule 1 Difficulty: Medium Learning Objective 1: 9.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 9.1 Solution: 31

[[[COMP: See submitted file "Carnes_I2025_Ch09_SM_TaxComplianceAndReportingProblem_Schedule 1 2023 page 2 Harris.pdf" for high-res version of the form below]]

Time on Task: 12 minutes Excel Problem 1) Title: Excel Problem: Casualty Loss Deduction Difficulty: Medium Learning Objective 1: 9.7 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis 32

Section Reference 1: 9.7 Solution: a.

(A) Cost

(B) FMV before

(C) FMV after

Lesser of (A) or ((B) − (C))

Insurance Casualty loss reimbursement available

$275,000

$330,000

$0

$275,000

($240,000)

Casualty loss available Less: $100 floor Less: 10% of AGI Casualty loss deduction

$35,000

$35,000 ( 100) (20,000) $14,900

b.

(A) Cost

(B) FMV before

(C) FMV after

Lesser of (A) or ((B) − (C))

Insurance Casualty loss reimbursement available

$275,000

$330,000

$0

$275,000

($240,000)

Casualty loss available Less: $100 floor Less: 10% of AGI Casualty loss deduction

$35,000

$35,000 ( 100) (40,000) $ 0

The deduction is zero because the casualty loss available is less than the threshold. c.

(A) Cost

(B) FMV before

(C) FMV after

Lesser of (A) or ((B) − (C))

Insurance Casualty loss reimbursement available

$200,000

$330,000

$0

$200,000

($240,000)

$0

Isabelle has a casualty gain of $40,000 because her insurance reimbursement is greater than the loss (cost of $200,000).

33

Input Area: Cost FMV Before FMV After Insurance Reimbursement Isabell's AGI

275000 330000 0 240000 200000

Calculation: =IF(B11="Gain","Gain Recognized on Casualty","Casualty Loss Available") Less : $100 Floor Less : 10% of AGI Casualty Loss Deduction

=IF((MIN(B5-B6,B4)-B7)<0,"Gain","Loss") =IF(B11="Gain",-(MIN(B5-B6,B4)-B7),MIN(B5-B6,B4)-B7) =IF(B11="Gain",0,-100) =IF(B11="Gain",0,-ROUND(B8*0.1,0)) =IF(SUM(B12:B14)<0,0,IF(B11="Gain",0,SUM(B12:B14)))

Time on Task: 20 minutes CPA Exam Preparation: Task-Based Simulation: Completing Schedule A

1) Title: Task-Based Simulation: Completing Schedule A Difficulty: Hard Learning Objective 1: 9.3 Learning Objective 2: 9.4 Learning Objective 3: 9.5 Learning Objective 4: 9.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 9.3-6 Solution: Line 1: Medical and dental expenses: $7,310 Doctor bill for ankle fracture Hospital bill from Northwestern Prescription medication Dental expenses Total Line 4: Medical deduction: $560 Total expenses Less: 7.5% AGI threshold Net deduction

$1,850 4,190 470 800 $7,310

$ 7,310 ( 6,750) $ 560

The expenses for over-the-counter drugs, tattoo removal, exercise classes, and the installation of the new pool for general exercise are not deductible medical expenses.

Line 5a: State and local income tax = $5,200 34

Taxpayers can deduct the greater of state and local income tax ($5,200) or general sales tax ($4,900).

Line 5b: State and local real estate taxes = $8,600 Line 5d: Total State and local taxes = $13,800 Line 5e: Deductible state and local taxes = $10,000 The limit on state and local taxes is $10,000.

Line 7: Total taxes paid = $10,000 Line 8a: Home mortgage interest expense = $30,000 Form 1098 from Best Mortgage Company reported mortgage interest expense of $34,000 and the outstanding mortgage principal was $850,000. The maximum acquisition debt to deduct interest expense on is $750,000 for mortgages taken out after December 15, 2017.

Maximum acquisition debt ($750,000) × Mortgage interest expense ($34,000) = $30,000 Actual mortgage debt ($850,000) Form 1098 from Huntley Hometown Mortgage Co. reported interest expense of $1,400.

This interest is not deductible because it is related to a home equity loan and the proceeds were used to buy a new car. Interest expense from home equity loans is deductible only if the proceeds are used to acquire or substantially improve a residence.

Line 10: Total deductible interest expense: $30,000 Line 11: Cash charitable contributions: Church charitable contribution Landmarks Illinois contribution Total cash contributions

$5,000 1,000 $6,000

The cash payments to the man experiencing homelessness and to the nephew are not deductible.

Line 12: Noncash charitable contributions: $200 The clothing contributed to the Salvation Army is deductible at fair market value of $200.

Line 14: Total charitable contributions: $6,200 Line 16: Other itemized deductions: $5,500 Robert received Form W-2G from Arlington International Racecourse to report gambling winnings of $5,500. Robert incurred gambling losses of $7,000. Robert may take 35

gambling losses to the extent of gambling winnings and therefore, may take a gambling loss of $5,500 as another itemized deduction.

Line 17: Total itemized deductions: $52,260 All other expenses provided by the Halls are nondeductible expenses.

• Uniforms for Robert’s job as a firefighter and EMT (employee business expenses are not deductible) • Groceries • Investment counseling advisory fee (investment expenses are not deductible) • Tax preparation fees Line Item Line 1 Line 2 Line 3 Line 4 Line 5a Line 5b Line 5c Line 5d Line 5e Line 6 Line 7 Line 8a Line 8b Line 8c Line 8e Line 9 Line 10 Line 11 Line 12 Line 13 Line 14 Line 15 Line 16

Description Medical and dental expenses Enter AGI Multiply line 2 by 7.5% Subtract line 3 from line 1 State and local taxes or sales tax State and local real estate taxes State and local personal property taxes Add lines 5a through 5c Enter smaller of Line 5d or $10,000 Other taxes Add lines 5e and 6 Home mortgage interest on Form 1098 Home mortgage interest not on Form 1098 Points not reported on Form 1098 Add lines 8a through 8d Investment interest expense Add lines 8e and 9 Gifts by cash or check Gifts other than by cash or check Carryover from prior year Add Lines 11 through 13 Casualty and Theft loss(es) Other Itemized deductions Add the amounts from Lines 4, 7, 10, 14, & Line 17 16 Time on Task: 30 minutes

36

Amount 7,310 90,000 6,750 560 5,200 8,600 0 13,800 10,000 0 10,000 30,000 0 0 30,000 0 30,000 6,000 200 0 6,200 0 5,500 52,260

Chapter 10—Business Expenses End-of-Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Easy Learning Objective 1: 10.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.1 Solution: In order to deduct a business expense, it must be ordinary, necessary, and reasonable in carrying on that trade or business.

Time on Task: 1 minute 2) Title: Discussion Question 2 Difficulty: Easy Learning Objective 1: 10.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.1 Solution: Dashawn will not be able to deduct any expenses from the horse farm. The activity is a personal activity and not a business; therefore, the expenses are personal and not deductible. Hobby activities are discussed in Chapter 11, LO2, Hobby Losses. However, Dashawn should also remember that income from hobbies is includible in gross income.

Time on Task: 2 minutes 3) Title: Discussion Question 3 Difficulty: Easy Learning Objective 1: 10.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.2 Solution: Lily’s miles traveling to and from work are considered commuting miles and not deductible as a business expense. Commuting costs are considered to be personal expenses, not business expenses.

Time on Task: 1 minute

4) Title: Discussion Question 4 Difficulty: Medium Learning Objective 1: 10.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.2 Solution: Transportation expenses are typically local and include automobile expenses, taxi fares, tolls, and parking. Travel expenses require a trip that is considered “away from home.” Travel expenses can include transportation, meals and lodging, and incidental expenses incurred while working away from home.

Time on Task: 3 minutes 5) Title: Discussion Question 5 Difficulty: Medium Learning Objective 1: 10.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.2 Solution: “Away from home” requires an overnight stay. Overnight does not have to be a 24-hour period of time, but rather a period requiring rest, sleep, or relief and is substantially longer than the average workday.

Time on Task: 2 minutes 6) Title: Discussion Question 6 Difficulty: Easy Learning Objective 1: 10.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.3 Solution: The expenses of $4,200 paid to become a nurse are not deductible education expenses on Schedule C. The education qualifies Miguel for a new trade or business and is not related to his business of being a delivery driver. Miguel may be able to obtain an education tax credit for educational expenses (see Chapter 16, Personal Tax Credits).

Time on Task: 2 minutes 7)

Title: Discussion Question 7 Difficulty: Medium Learning Objective 1: 10.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.3 Solution: Because the meals are business meals, she can deduct the expense. The business meals deduction is allowed at 50% of the total so $550 is deductible in 2024.

Time on Task: 2 minutes 8) Title: Discussion Question 8 Difficulty: Easy Learning Objective 1: 10.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.3 Solution: Edna cannot deduct any of her golf expenses. Entertainment expenses are not deductible.

Time on Task: 2 minutes 9) Title: Discussion Question 9 Difficulty: Medium Learning Objective 1: 10.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.4 Solution: JMJ Company can deduct all of its business interest expense of $24,000. Its average annual gross receipts for the last three years do not exceed $30 million so the business interest limitation does not apply.

Time on Task: 2 minutes 10) Title: Discussion Question 10 Difficulty: Medium Learning Objective 1: 10.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.5

Solution: A business bad debt is treated as an ordinary loss. A non-business bad debt is treated as a shortterm capital loss.

Time on Task: 2 minutes 11) Title: Discussion Question 11 Difficulty: Medium Learning Objective 1: 10.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.5 Solution: For financial accounting purposes under GAAP, an estimate may be used to calculate the bad debt expense. For tax purposes, only the direct write-off method can be used. Sage Company must know exactly which accounts receivable are not collectible and then deduct only that exact amount. Therefore, Sage Company cannot deduct the $4,500 bad debt expenses that is recorded on its financial accounting records.

Time on Task: 3 minutes 12) Title: Discussion Question 12 Difficulty: Easy Learning Objective 1: 10.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.6 Solution: The only items that can create a net operating loss are casualty losses and business losses.

Time on Task: 1 minute 13) Title: Discussion Question 13 Difficulty: Medium Learning Objective 1: 10.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.6 Solution: If a taxpayer had an NOL in 2019, the taxpayer may carryback the NOL five years and then carry it forward indefinitely until the NOL is completely used. It can offset up to 100% of the income for 2014-2020 and, if there is still an amount remaining to carry forward, it can offset 80% of the income in 2021 and later.

Time on Task: 3 minutes 14) Title: Discussion Question 14 Difficulty: Medium Learning Objective 1: 10.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.7 Solution: An excess business loss exists when a noncorporate taxpayer’s aggregate business deductions for the year exceeds: a. The sum of aggregate gross income or gains of the taxpayer, and b. A threshold amount of $610,000 for married filing joint and $305,000 for all other taxpayers (2024).

Time on Task: 3 minutes 15) Title: Discussion Question 15 Difficulty: Easy Learning Objective 1: 10.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.7 Solution: The excess business loss rules apply to a taxpayer’s businesses in the aggregate.

Time on Task: 1 minute Multiple Choice Questions 1) Answer: d Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 10.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.1 Solution: The correct answer is All of these.

A business expense must be ordinary, necessary, and reasonable in carrying on a trade or business to be deductible.

Time on Task: 1 minute

2) Answer: d Title: Multiple Choice Question 2 Difficulty: Easy Learning Objective 1: 10.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.2 Solution: The correct answer is 67 cents per mile.

The standard mileage rate for business miles driven in 2024 is 67 cents per mile.

Time on Task: 1 minute 3) Answer: b Title: Multiple Choice Question 3 Difficulty: Medium Learning Objective 1: 10.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.2 Solution: The correct answer is IT assigns Travis to a job in Chicago that will last for six months.

In order to deduct meals for a business trip, the taxpayer must be considered away from home for a temporary period. Away from home requires at least rest or an overnight stay. Temporary indicates that the travel will be for a short period of time that does not exceed a year. If the taxpayer relocates for an indefinite time period, then that new location becomes his new tax home.

Time on Task: 4 minutes 4) Answer: c Title: Multiple Choice Question 4 Difficulty: Medium Learning Objective 1: 10.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.3 Solution: The correct answer is $1,885.

Three out of the five days were for business (60%). Airfare is 100% deductible because the business days are more than 50% of the total days. Meals are allowed at 50% for three days, or

$75 ($25 × 3). Lodging for three days is $360. The seminar fee is 100% deductible. Therefore, $700 + $750 + $75 + $360 = $1,885 is deductible.

Time on Task: 4 minutes 5) Answer: b Title: Multiple Choice Question 5 Difficulty: Medium Learning Objective 1: 10.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.3 Solution: The correct answer is $2,400.

Levi can deduct only 50% of the cost of business meals. Levi’s net self-employment income is $2,400, [$14,000 − $11,000 – (50%  $1,200)].

Time on Task: 3 minutes 6) Answer: b Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 10.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.3 Solution: The correct answer is $600.

Business expenses are deductible if ordinary, necessary, and reasonable. Dues to the club are not deductible. All entertainment expenses are not deductible. The business-related meals and drinks after golf are deductible at 50% because a separate invoice is paid and not included with the golf entertainment expense.

Time on Task: 5 minutes 7) Answer: b Title: Multiple Choice Question 7 Difficulty: Easy Learning Objective 1: 10.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.4 Solution:

The correct answer is 30%.

The correct percentage of limitation on business interest expense for 2024 is 30%.

Time on Task: 1 minute 8) Answer: c Title: Multiple Choice Question 8 Difficulty: Medium Learning Objective 1: 10.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.5 Solution: The correct answer is $2,800.

For tax purposes, the direct write-off method is used. Only accounts receivable actually written off in the year are deductible.

Time on Task: 2 minutes 9) Answer: c Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 10.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.6 Solution: The correct answer is Carry it forward indefinitely.

For a net operating loss (NOL) generated in 2024, Declan can carry it forward indefinitely.

Time on Task: 2 minutes 10) Answer: b Title: Multiple Choice Question 10 Difficulty: Medium Learning Objective 1: 10.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.7 Solution: The correct answer is $10,000.

Demi has a loss of $315,000 ($420,000 – $735,000) in 2024. Her excess business loss is $10,000 ($315,000 – threshold of $305,000). Demi has a usable business loss of $305,000. She can carryforward the excess business loss of $10,000 indefinitely.

Time on Task: 4 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 10.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.1 Solution: Expenses related to trade or business activities are deductible if they are: • •

incurred in operating a trade or business, and are ordinary, necessary, and reasonable.

Tangerine Company must be able to prove that the $900,000 salary paid to the CEO is considered reasonable. Because a comparable company in a similar location pays its CEO only $200,000, Tangerine may not be able to justify paying a $900,000 salary to its CEO. Time on Task: 4 minutes 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 10.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.1 Solution: a. Because Tobias is not currently in the clock shop business, the $2,650 of investigation expenses are classified as start-up costs. Tobias can deduct up to $5,000 of the costs.

Because the costs of $2,650 are less than the maximum deduction of $5,000, Tobias can deduct the entire $2,650. b. Tobias cannot deduct any of the $2,650 because he is not already in the clock shop business. Costs incurred before making a decision to begin or acquire a specific business are personal and nondeductible.

Time on Task: 6 minutes 3) Title: Brief Exercise 3

Difficulty: Medium Learning Objective 1: 10.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.2 Solution: Tireless Company can deduct a total of $2,000 for the cruise conference. The cost allowed would be $2,100 [(2  $350)  3 days], but this cost is limited to a deduction of $2,000.

Time on Task: 4 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 10.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.3 Solution: The expenses are deductible if the education: • •

Maintains or improves existing skills required in a current job or Meets the requirements of an employer or imposed by law to retain employment status.

Education expenses are not deductible if the taxpayer incurs them: • •

To meet the minimum standards of a current job or To qualify the taxpayer for a new trade or business.

In addition to tuition and fees, the student can deduct the cost of required books and travel to attend classes.

Time on Task: 4 minutes 5) Title: Brief Exercise 5 Difficulty: Medium Learning Objective 1: 10.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.4 Solution: Adjusted taxable income does not include business interest expense. Strawberry Company’s adjusted taxable income equals:

Revenue COGS Salaries paid Advertising Depreciation expense Amortization expense Office Expense Adjusted Taxable Income Time on Task: 6 minutes

$1,325,000 ( 400,000) ( 230,000) ( 12,000) ( 25,000) ( 6,000) ( 1,200) $ 650,800

6) Title: Brief Exercise 6 Difficulty: Medium Learning Objective 1: 10.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.5 Solution: A business bad debt is any debt created in the ordinary course of business operations. Business bad debts primarily arise from: • •

Lending money by those in the trade or business of providing loans, or Credit extended to customers who purchase goods or services from a business.

A nonbusiness bad debt is any bona fide loan a taxpayer does not make in a business capacity but that has a bona fide profit motive.

Time on Task: 4 minutes 7) Title: Brief Exercise 7 Difficulty: Medium Learning Objective 1: 10.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.6 Solution: Only business losses and casualty losses can create an NOL. Losses from rental activities are treated as business losses for purposes of computing the NOL. A negative AGI indicates that a business loss has occurred which creates an NOL, whereas a taxable loss could be caused by itemized deductions exceeding AGI. In that case, once the itemized deductions other than casualty losses are added back, the taxpayer will not have an NOL. Time on Task: 4 minutes 8)

Title: Brief Exercise 8 Difficulty: Easy Learning Objective 1: 10.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 10.7 Solution: The limitation on excess business losses is for noncorporate taxpayers and applies to losses from sole proprietorships, partnerships, S corporations, and limited liability companies.

Time on Task: 2 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Easy Learning Objective 1: 10.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.1 Solution: All of the expenses listed are legitimate business expenses except the tractor. It is not ordinary, necessary, or reasonable for the bakery to purchase a tractor.

Time on Task: 2 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 10.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.1 Solution: a. Addy cannot deduct any of these expenses because she incurred them in her role as an employee. b. Addy cannot deduct any of these expenses because she incurred them in her role as an employee. She also must recognize income of $1,125 for the reimbursements because her employer does not have an accountable plan. c. Addy still cannot deduct any of these expenses. However, the good news for her is that because the employer has an accountable plan, she does not have to include the $1,125 in income.

Time on Task: 6 minutes

3) Title: Application Problem 3 Difficulty: Easy Learning Objective 1: 10.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.1 Solution: Scenario A: Because Ahana is not currently in the art studio business, the $54,500 of investigation expenses are classified as start-up costs. Ahana can generally deduct up to $5,000 of the costs, and the remaining costs must be amortized over 180 months. Because Ahana’s start- up costs are in excess of $50,000, the $5,000 deduction is phased-out for each dollar of start-up costs in excess of $50,000. Ahana can take an immediate deduction of $500 [$5,000 − ($54,500 − $50,000)]. The remaining $54,000 ($54,500 − $500) must be amortized over 180 months, or $300 per month. For the current year, she will amortize seven months of start-up costs, or $2,100 (7  $300), because the store began operating on June 1. The total cost that Ahana can deduct in the current year is $2,600 ($500 + $2,100).

Scenario B: Ahana cannot deduct any of the $54,500 because she is not already in the art studio business. Costs incurred before making a decision to begin or acquire a specific business are personal and non-deductible.

Time on Task: 6 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 10.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.2 Solution: The 4,100 miles driven between home and the office are considered commuting miles and are not deductible. Because he has a regular office, the 6,500 miles driven between home and the various worksites are deductible. The 3,300 miles driven between his office and the various worksites are deductible. The total business miles are 9,800 and the deduction is $6,566 (9,800  0.67) in 2024.

Time on Task: 4 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 10.2 Standard 1: AACSB || Analytic

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.2 Solution: Hiromi can deduct all of her auto expenses times her business use percentage: Gas Lease payments Oil changes Insurance Repairs License fee Total

$ 880 4,200 175 1,200 475 125 $7,055  13,000/16,000 = $5,732

The parking fees for business trips of $140 are deductible in full, so the total deduction is $5,872 ($5,732+ $140).

The standard mileage rate would produce a deduction of $8,710 (13,000  0.67). The parking fees of $140 are added to this total for a deduction of $8,850. Hiromi should use the standard mileage rate and deduct $8,850 as her total business mileage expense.

Time on Task: 8 minutes 6) Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 10.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.2 Solution: a. Yes, Rehema can deduct her travel expenses while away from home in Bloomington.

Indianapolis is her tax home, and she is temporarily assigned away from home and is incurring a duplication of expenses that she has in Indianapolis. b. No, Rehema is no longer away from home because the assignment is no longer temporary and therefore the travel expenses are not deductible.

Time on Task: 6 minutes 7) Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 10.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.2

Solution: a. Yes, all of Roxanne’s travel expenses are deductible, as well as the meals at 50%. b. No, none of Roxanne’s travel expenses are deductible because the conference is not directly related to her trade or business.

Time on Task: 6 minutes 8) Title: Application Problem 8 Difficulty: Medium Learning Objective 1: 10.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.2 Solution: Martin can deduct all of his airfare of $4,000 because his trips were primarily for business. He can deduct lodging for his 20 business days at $150 each for a total of $3,000 and meals for his 20 business days at $75 each  50% for a total of $750. Martin’s total deductible travel expenses are $7,750 ($4,000 + $3,000 + $750).

Time on Task: 5 minutes 9) Title: Application Problem 9 Difficulty: Medium Learning Objective 1: 10.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.2 Solution: Even though Nelson is not considered away from home, the lodging is deductible if the following conditions are met: • • • •

The employer requires the employee to stay overnight.

The lodging does not exceed five days and does not occur more than once per quarter.

The employee is required to participate in the event that necessitates the overnight stay.

The lodging is not lavish or extravagant.

ClearSkin can deduct $1,160 [$800 + $250 + $50 ($100  50%) + $60] Time on Task: 5 minutes 10) Title: Application Problem 10 Difficulty: Medium Learning Objective 1: 10.3

Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.3 Solution: a. Joanne may deduct her education expenses because as an attorney, she is required by law to obtain CPE hours to maintain her license. b. Dale cannot deduct his education expenses because his courses qualify him for a new trade or business. c. Becky cannot deduct her expenses where she uses travel as a form of education. d. Gary cannot deduct his education expenses because a law degree would qualify him for jobs other than operating an accounting firm.

Time on Task: 8 minutes 11) Title: Application Problem 11 Difficulty: Medium Learning Objective 1: 10.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.3 Solution: Entertainment expenses are not deductible. Meredith can deduct 50% of her meal expenses $1,563 [50%  ($975 + $2,150)]. The meals after golf are deductible because a separate receipt was provided that did not include the charge for golf. Meredith can deduct the gifts but only at $25 each per vendor for a total of $1,250 ($25  50). Her total deductible business expenses are $2,813 ($1,563 + $1,250).

Time on Task: 8 minutes 12) Title: Application Problem 12 Difficulty: Easy Learning Objective 1: 10.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.4 Solution: Golden Company’s business interest deduction limitation is $565,000 [$85,000 (business interest income) + $480,000 (30%  $1,600,000)]. Therefore, Golden Company can deduct all its $488,000 of business interest expense.

Time on Task: 3 minutes 13) Title: Application Problem 13

Difficulty: Medium Learning Objective 1: 10.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.4 Solution: Reno Company’s business interest deduction limitation is $372,000 [$72,000 (business interest income) + $300,000 (30%  $1,000,000)]. Therefore, Reno Company can deduct $372,000 of business interest expense and $72,000 will be carried forward indefinitely.

Time on Task: 4 minutes 14) Title: Application Problem 14 Difficulty: Easy Learning Objective 1: 10.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.5 Solution: The company can deduct the $34,500 of actual write-offs on the tax return. For tax purposes, only the direct write-off method may be used to calculate deductible bad debt expense.

Time on Task: 3 minutes 15) Title: Application Problem 15 Difficulty: Easy Learning Objective 1: 10.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.5 Solution: a. Because Holiday is a cash basis company, it never recorded the $10,000 in income, and therefore cannot deduct a business bad debt on its tax return. b. Because Holiday is an accrual-based company, it did record the $10,000 in income, and therefore can deduct a business bad debt on its tax return.

Time on Task: 4 minutes 16) Title: Application Problem 16 Difficulty: Medium Learning Objective 1: 10.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting

Standard 3: Bloom's || Application Section Reference 1: 10.5 Solution: Yes, Dharma can deduct the $9,000 as a bad debt. It is considered a short-term capital loss because it is a non-business bad debt. Even though the loan was used for a business venture, it was not used by Dharma. It is a non-business bad debt because Dharma is not in the business of loaning money, but because she was charging interest on the loan, it was a legitimate loan. As a short-term capital loss, the deduction is generally limited to $3,000 per year.

Time on Task: 4 minutes 17) Title: Application Problem 17 Difficulty: Medium Learning Objective 1: 10.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.6 Solution: Cloudy Day will only be able to use $88,000 of the 2024 NOL ($110,000 taxable income  80%). Cloudy Day will have $22,000 ($110,000 − $88,000) of taxable income for 2025. The remaining $7,000 ($95,000 − $88,000) NOL will be carried forward to 2026.

18) Title: Application Problem 18 Difficulty: Hard Learning Objective 1: 10.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.6 Solution: Step 1: Calculate taxable loss and Step 2: Identify business income, business deductions, nonbusiness income, and nonbusiness deductions.

Wages Rental loss Interest income Capital gains NOL carryforward from 2017 Adjusted gross income Less: Itemized deductions: Mortgage interest expense $ 12,000 Real estate taxes $ 6,000 State income taxes $ 3,500 Total itemized deductions

$ 54,000 ( 76,000) 1,500 2,300 ( 13,000) ($31,200)

( 21,500)

Business income Business loss Non-business income Non-business income NOL

Taxable loss

($52,700)

Step 3: We ask if Saquon itemized his deductions. He did, because itemized deductions were greater than the standard deduction, so we can skip to step 5.

Step 4: Not applicable because the standard deduction was not used.

Step 5: If the taxpayer deducted itemized deductions in computing the taxable loss, then add back the following: Itemized Deductions ($21,500) – Personal casualty losses ($0) – Nonbusiness income ($3,800), but not less than zero = $ 17,700 Step 6: Not applicable because there were no net capital losses to add back.

Step 7: Add back NOL carryforward Net operating loss for the current year Time on Task: 12 minutes

$ 13,000 ($22,000)

19) Title: Application Problem 19 Difficulty: Medium Learning Objective 1: 10.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.7 Solution: a. Paris has generated a net loss of $360,000 ($880,000 − $1,240,000). In 2024, Paris can deduct the loss to the extent of $305,000 because she is filing as single. The $305,000 loss can be used to offset nonbusiness income and she can carry the remaining $55,000 as part of a net operating loss. b. Paris has generated a net loss of $360,000 ($880,000 − $1,240,000). In 2024, Paris can deduct the loss to the extent of $610,000 because she is filing as married filing jointly. As such, all of the $360,000 loss can be used to offset nonbusiness income.

Time on Task: 6 minutes 20) Title: Application Problem 20 Difficulty: Medium Learning Objective 1: 10.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 10.7 Solution:

The aggregate net loss from all of Evan and Morgan’s trades and businesses is $612,000 ($80,000 − $197,000 − $495,000). They must limit their business loss deduction for 2024 to $610,000. The remaining loss of $2,000 is included as part of their NOL for 2024 and can be carried forward to future tax years.

Time on Task: 5 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Difficult Learning Objective 1: 10.2 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 10.2 Solution: a. The rules for foreign travel apply to Keir. Because Keir is away from home for more than 7 days and more than 25% of his time is personal, only 71% (10 days business/ 14 days total) of the transportation is deductible. Keir can deduct: Airfare and rail pass $2,485 (3,500  71%) Lodging per day 3,250 ($325  10) Meals per day 875 ($175  10  50%) Total $6,610 b. If Keir only spends 3 days sightseeing, no allocation of transportation is needed because his personal time is only 23% of the total travel time (3 days personal/13 days total). Therefore, he can deduct 100% of the airfare and rail pass and his total deduction is $7,625 ($3,500 + $3,250 + $875).

Time on Task: 8 minutes 2) Title: Tax Planning Problem 2 Difficulty: Difficult Learning Objective 1: 10.6 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 10.6 Solution: The tax results to Brandon will be the same whether he makes the purchase in 2023 or 2024.

NOLs incurred in 2023 cannot be carried back. If Brandon incurs the expense in 2023, the $23,000 NOL will be carried forward to 2024. If he incurs the expenses in 2024, then the tax effect of the expenses will also be in 2024.

Time on Task: 5 minutes

Communication Problem 1) Title: Communication Problem: Business Meals and Entertainment Difficulty: Medium Learning Objective 1: 10.3 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 10.3 Solution: Memo to Client Dear Avery, It was nice to meet with you last week to discuss this year’s tax planning. I have reviewed the receipts and QuickBooks file that you gave me. Unfortunately, even though the entertainment was for business purposes, these expenses are not deductible because entertainment expenses are not deductible beginning in 2018. I did notice that you only have receipts for 65% of your dinner meal expenses. Therefore, only $1,576 ($2,425 65%) is eligible for a deduction. You must be able to substantiate the expense in order to deduct it on your tax return. Because you had a separate receipt for the meals after the entertainment events, these expenses are deductible. Your total meals expense is $4,111 ($675 + $1,576 + $1,860), and 50% ($2,056) of that is deductible in 2024.

Please let me know if you have any questions on this matter or anything else that I can help you with.

Sincerely, Carnes & Youngberg, CPAs Tax memo to the file Facts: Avery owns and operates several car dealerships in Detroit and frequently takes clients out to lunch or dinner or entertains them. Avery has provided a list of his expenses pertaining to meal and entertainment.

Business Meals: Meals (lunch) Meals (dinner) Meals after entertainment events

$ 675 $2,425 (65% substantiated) $1,860 (separate receipts provided)

Business Entertainment: Tickets to Red Wings games

$2,000

Tickets to Lions games Tickets to Tigers games

$1,800 $3,600

Issue: What expenses are deductible on Avery’s tax return?

Conclusion: None of the entertainment expenses are deductible. Meal expenses of $2,056 are deductible.

Analysis: Per IRC §274(a)(1)(A), starting in 2018, entertainment expenses are no longer allowed. Per IRC §274(n)(1), meals are subject to a 50% reduction in allowable deductible expenses. The meal expense must be properly substantiated in order for the meal to be deductible. Therefore, $1,576 ($2,425  65%) of the dinner meals are eligible for a deduction.

Because there are separate receipts for the meals after the entertainment events, these expenses are deductible. The total meals expense is $4,111 ($675 + $1,576 + $1,860), and 50% ($2,056) is deductible in 2024.

Time on Task: 15 minutes Ethics Problem 1) Title: Ethics Problem: Proper Classification Difficulty: Medium Learning Objective 1: 10.1 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 10.1 Solution: You must advise Johnny that his tax returns are inaccurate and need to be amended. Per IRC §162(a), business expenses must be ordinary and necessary for a trade or business. The oven is not an ordinary and necessary expense for the gas station, and therefore is not deductible on the gas station tax return. Under Circular 230 §10.21, Knowledge of client’s omission, and §10.22, Diligence as to accuracy, the practitioner must advise the client of their previous error and make sure that the tax return is accurate going forward. Also, under Statement on Standards for Tax Services No. 2.3.2, "When preparing or signing a return, or portion of a return, a member may, in good faith, rely on information furnished, without verification, by the taxpayer or by third parties. However, a member should not ignore the implications of information furnished and should make reasonable inquiries if the information furnished appears to be incorrect, incomplete, or inconsistent either in its face or on the basis of other facts known to the member."

Amended returns should be filed to reflect the oven purchase on the restaurant business tax return and not on the gas station business income tax return. If the client refuses to make the necessary corrections, you should consider resigning from the engagement.

Research Problems 1)

Title: Research Problem 1: Deductibility of Foreign Travel Expenses Difficulty: Medium Learning Objective 1: 10.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 10.2 Solution: Careful attention must be made to the deductibility of travel expenses abroad. According to IRC §274(c) and Reg. 1.274-4, when travel is international, specific rules apply to the possible allocation of the transportation portion of the trip. Transportation expenses must be allocated between business and personal unless: 1. The taxpayer is away from home for seven days or less, or 2. Less than 25% of the time was for personal purposes.

If the trip is primarily for pleasure, then no transportation is deductible. In counting the total days, travel days to and from the United States are considered business days. Possible expenses may include airfare, lodging, meals, and rental car costs.

One such example of these rules you could present to students is the following: If Whitney travels from her home in the United States and flies to London and spends 14 days (including 2 travel days) conducting business and 5 days sightseeing for personal pleasure, her trip is primarily for business. Because Whitney is away from home for more than 7 days and more than 25% of her time is personal, only 74% (14 days business/ 19 days total) of the transportation is deductible. Assume she has the following expenses: Airfare and rail pass Lodging per day Meals per day $ 200

$5,000 $ 400

Whitney can deduct: Airfare and rail pass Lodging per day Meals per day Total

$ 3,700 ($5,000  74%) 5,600 ($400  14) 1,400 ($200  14  50%) $10,700

If Whitney only spends 4 days sightseeing, the tax law requires no allocation of transportation because her personal time is only 22% (4 days personal/18 days total). Therefore, Whitney can deduct the entire $5,000 of Airfare and rail pass for a total deduction of $12,000 ($5,000 + $5,600 + $1,400) Time on Task: 10 minutes 2) Title: Research Problem 2: Determining Deductibility of Expenses

Difficulty: Medium Learning Objective 1: 10.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 10.1 Solution: For expenses to be deductible, they must be ordinary, necessary, and reasonable if concerning salaries (IRC §162(a)). According to Combs v. Commissioner, 2019 T.C. Memo. 96, expenses must have a business purpose and be substantiated. In this recent decision, the Tax Court held that the payment of personal expenses from a corporate bank account constituted a constructive dividend that was taxable to the shareholder. The Court held that various payments for personal expenses resulted in a decrease of allowable expenses for the corporation and an increase in dividend income for the shareholder. Both resulted in a Notice of Deficiency being issued to the corporation and the shareholder. You should advise Casper of the following: • • •

The payment for the Lexus is not a business expense if he did not use the auto for his business activities.

The payments made to his daughter are unusually high for a 12-year-old to receive for one day of filing work per week. He should pay her a reasonable wage for filing work and then the payments would be deductible.

The monthly payments for the apartment in NYC are not deductible if they do not serve a business purpose.

You should ensure that Casper understands that both SCN and he will be affected if he does not correct these errors in his financial reporting and tax return reporting. SCN will not be entitled to a deduction on Schedule C for these payments which will increase the net profit from the business.

Time on Task: 10 minutes Excel Problem 1) Title: Excel Problem: Business Interest Expense Deduction Difficulty: Medium Learning Objective 1: 10.4 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 10.4 Solution: [[See submitted file "Carnes_I2025_Ch10_SM_Excel Problem.xlsx"]] a. Chocolate Company’s business interest deduction limitation is $947,000 [$47,000 (business interest income) + $900,000 (30%  $3,000,000)]. Therefore, Chocolate Company can deduct all of its $425,000 of business interest expense. b. Chocolate Company’s business interest deduction limitation is $347,000 [$47,000 (business interest income) + $300,000 (30%  $1,000,000)]. Therefore, Chocolate

Company can deduct $347,000 of business interest expense and $78,000 will be carried forward indefinitely. c. Because Chocolate’s average gross receipts for the last three years do not exceed $30 million, Chocolate can deduct all of its $425,000 of business interest expense.

Input Area: Adjusted Taxable Income

3,000,000

Average Gross Receipts - Last 3 Years

30,000,000

Business Interest Income

47,000

Business Interest Expense

425,000

Calculation: Business Interest Deduction Limitation

947,000

Business Interest Deduction

425,000

Input Area: Adjusted Taxable Income Average Gross Receipts - Last 3 Years Business Interest Income Business Interest Expense

3000000 30000000 47000 425000

Calculation: Business Interest Deduction Limitation Business Interest Deduction

=IF(B5>=30000000,B6+B4*0.3,B7) =MIN(B10,B7)

Time on Task: 20 minutes CPA Exam Preparation: Task-Based Simulation Title: Task-Based Simulation: Completion of Schedule C Difficulty: Hard Learning Objective 1: 10.1-3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 10.1-3 Solution: [[See submitted file: "Carnes_Individual_2025_Update_Ch10_SM_TBS_Form 1040 Sch C 2023 blank.pdf"]] Rationale:

Line Item Line 1 Line 4 Line 5 Line 6 Line 7 Line 8 Line 9 Line 15 Line 18 Line 20 Line 22 Line 24a Line 24b Line 25 Line 26 Line 27a Line 28 Line 29 Line 30 Line 31

Description

Amount

Gross receipts or sales Cost of Goods Sold Gross profit, subtract Line 4 from Line 1 Other income Gross income Advertising Car and truck expenses* Insurance Office expense Rent expense Supplies Travel** Business Meals*** Utilities Wages Other expenses – Conference fee Total Expenses Tentative Profit, subtract Line 28 from Line 7 Expenses for business use of your home Net profit or (loss)

422,000 0 422,000 0 422,000 12,000 6,161 24,000 4,800 36,000 1,200 878 440 1,800 136,000 450 223,729 198,271 0 198,271

* Willy can choose between actual auto expenses incurred and substantiated and the standard mileage rate applied to business miles to determine the best overall deduction. Willy’s actual auto expenses times the business use percentage are shown below. The parking fines are not deductible.

Gas Oil changes Insurance Repairs License fee Total

$ 2,000 175 1,200 360 150 $ 3,885  8,300/10,400 = $3,101

The parking fees for business trips of $600 are deductible in full, so the total deduction is $3,701.

The standard mileage rate for 2024 would produce a deduction of $5,561 (8,300  0.67). The parking fees of $600 are added to this total for a deduction of $6,161. Willy should use the standard mileage rate and deduct $6,161 as his total business mile expense. ** Willy can deduct all of his airfare of $375 because his trip was primarily for business. He can deduct lodging for his 3 business days at $130 each for a total of $390 and meals for his 3 business days at $75 each  50% for a total of $113. Willy’s total deductible travel expenses are

$878 ($375 + $390 + $113). The conference fee is deductible and is listed on line 27a as another expense. *** Business meals are 50% deductible.

Chapter 11—Limitations on Business Losses and Expenses End-of-Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Easy Learning Objective 1: 11.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.1 Solution: Self-employed taxpayers can deduct home office expenses on Schedule C. Employees cannot deduct home office expenses because they are unreimbursed employee business expenses which are not deductible as an itemized deduction beginning in 2018.

Time on Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Easy Learning Objective 1: 11.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.1 Solution: Self-employed taxpayers can deduct home office expenses if a portion of the residence is used exclusively on a regular basis as either: • The principal place of business for any trade or business of the taxpayer, or • A place of business used by clients, patients, or customers.

Time on Task: 3 minutes 3) Title: Discussion Question 3 Difficulty: Medium Learning Objective 1: 11.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.2 Solution: The regulations indicate 9 factors that taxpayers should consider in determining whether an activity is profit-seeking or a hobby: 1

1. Is the activity carried on like a business, such as having a separate checking account, an employer identification number (EIN) assigned by the IRS, a social media presence, and business cards?

2. Does the business operator have the knowledge and skills necessary to be successful in this business?

3. How much time and effort does the individual spend on the activity?

4. Is there an expectation that some of the assets used in the activity will increase in value? (This factor applies primarily to real estate and investment activities.)

5. If the activity has a history of losses, has the operator been successful with creating profits for similar ventures in the past?

6. What has the history of losses and profits been from the activity?

7. What is the relative amount of profits and losses for the activity from one year to the next?

8. What is the relative amount of income the taxpayer earns from this activity in comparison to other sources of income?

9. Does the activity have recreational appeal for the taxpayer?

Time on Task: 4 minutes 4) Title: Discussion Question 4 Difficulty: Medium Learning Objective 1: 11.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.2 Solution: The presumptive rule assumes that an activity is profit-seeking if the activity shows a profit for at least three of the previous five tax years. The IRS has the burden of proof if it wishes to rebut that presumption.

Time on Task: 3 minutes 5) Title: Discussion Question 5 Difficulty: Medium Learning Objective 1: 11.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.3 Solution: A vacation home is used primarily for personal use if the residence is rented for fewer than 15 days in a year. Rental income is not reported for a home used primarily for personal use and mortgage interest expense and real estate taxes are deductible as itemized deductions. A vacation home is used primarily for rental use if the residence is rented for 15 days or more in a year and 2

is not used for personal purposes for more than the greater of 1) 14 days or 2) 10% of the total days rented. The rental income is reported in income on page 1 of Schedule E. The expenses must be allocated between personal use and rental use. Mortgage interest expense is deductible only to the extent allocable to rental use. The remainder is not deductible as an itemized deduction. Real estate taxes are allocated and deducted on either Schedule E or Schedule A. A loss may be taken on Schedule E for a rental property.

Time on Task: 4 minutes 6) Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 11.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.3 Solution: If a vacation home is determined to be personal/rental use, then expenses are allocated and deducted only to the extent of rental income generated. The taxpayer cannot deduct a loss.

Unused expenses that were allocated to rental can be carried forward and used in a future year when there is sufficient income.

Time on Task: 3 minutes 7) Title: Discussion Question 7 Difficulty: Medium Learning Objective 1: 11.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.4 Solution: The initial at-risk amount includes the amount of cash and the adjusted basis of property contributed to the activity plus any amounts borrowed for use in the activity for which the taxpayer is personally liable.

Time on Task: 3 minutes 8) Title: Discussion Question 8 Difficulty: Difficult Learning Objective 1: 11.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.4 Solution: 3

The at-risk amount includes qualified nonrecourse debt which is secured by the real property used in the activity. The debt is qualified nonrecourse debt if it is borrowed from a lender engaged in the business of making loans (such as banks and savings and loan associations) provided that the lender is not the promoter or seller of the property or a party related to either.

Qualified nonrecourse debt also includes money borrowed from or guaranteed by any federal, state, or local government.

Time on Task: 4 minutes 9) Title: Discussion Question 9 Difficulty: Easy Learning Objective 1: 11.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.5 Solution: A passive activity results from a trade or business or income-producing activity in which the taxpayer does not materially participate in its management. Rental activities (except in limited circumstances) are defined to be passive.

Time on Task: 2 minutes 10) Title: Discussion Question 10 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.5 Solution: Because David’s adjusted gross income is less than $100,000 and he actively participates in the management of the property, he will be able to deduct his passive activity loss of $11,200.

Time on Task: 3 minutes 11) Title: Discussion Question 11 Difficulty: Easy Learning Objective 1: 11.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.5 Solution: The passive activity loss rules apply to individuals, estates, trusts, personal service corporations, and closely held C corporations.

4

Time on Task: 2 minutes 12) Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 11.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.6 Solution: Only considering the use of losses, a flow through entity such as an S corporation, single member LLC, or a sole proprietorship would be the best choice. With these entity types, Bethany can use her losses to offset other types of income currently with these entity types. If she would not mind having a business partner, partnerships are also flow-through entities and Bethany could use her losses from a partnership entity to offset other types of income as well.

Time on Task: 3 minutes Multiple Choice Questions 1) Answer: b Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 11.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.1 Solution: The correct answer is Form 8829.

Taxpayers use Form 8829 to report a home office deduction unless using the simplified method.

Time on Task: 2 minutes 2) Answer: a Title: Multiple Choice Question 2 Difficulty: Medium Learning Objective 1: 11.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.2 Solution: The correct answer is Sharon has a hobby, and she must include her gross income on Form 1040.

Sharon must report her gross income on her tax return as other income.

5

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Time on Task: 2 minutes 3) Answer: c Title: Multiple Choice Question 3 Difficulty: Easy Learning Objective 1: 11.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.2 Solution: The correct answer is $4,800.

Corey must report his gross income from his hobby of $4,800. He cannot deduct his hobby expenses.

Time on Task: 2 minutes 4) Answer: a Title: Multiple Choice Question 4 Difficulty: Easy Learning Objective 1: 11.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.3 Solution: The correct answer is Primarily personal use.

If a residence is rented for fewer than 15 days in a year, it is treated as a personal use residence.

Time on Task: 2 minutes 5) Answer: c Title: Multiple Choice Question 5 Difficulty: Medium Learning Objective 1: 11.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.3 Solution: The correct answer is Personal/rental use.

If Rocky rents the vacation home for 75 days per year and uses it for personal purposes for 120 days, it is personal/rental property. He rented it for more than 15 days and the personal use of 120 days exceeds the greater of 14 days or 10% of the total days rented.

Time on Task: 3 minutes 6

6) Answer: c Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 11.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.4 Solution: The correct answer is $31,000.

Tyrone is at-risk for losing $10,000 cash plus $15,000 adjusted basis of the stock plus 25% of the recourse debt of $6,000.

Time on Task: 3 minutes 7) Answer: c Title: Multiple Choice Question 7 Difficulty: Easy Learning Objective 1: 11.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 11.5 Solution: The correct answer is 501.

If an individual participates in the activity for more than 500 hours during the current year, he is a material participant in the activity.

Time on Task: 2 minutes 8) Answer: c Title: Multiple Choice Question 8 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.5 Solution: The correct answer is $50,500.

Yanni’s adjusted gross income is wages of $50,000, interest income of $500, passive income of $10,000 offset by $10,000 of the passive loss. The remaining $3,000 of the passive loss is carried forward as a suspended passive activity loss.

Time on Task: 3 minutes 7

9) Answer: a Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.5 Solution: The correct answer is If Bruce actively participates in managing the rental property, he can deduct the $13,000 loss against his other income.

Active participation is sufficient to allow losses up to $25,000 for rental real estate.

Time on Task: 5 minutes 10) Answer: d Title: Multiple Choice Question 10 Difficulty: Medium Learning Objective 1: 11.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.6 Solution: The correct answer is $6,500 income.

Josiah must include the $6,500 of partnership income and cannot deduct the passive loss of $4,000. Taxpayers can use passive losses only to offset passive income.

Time on Task: 3 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Easy Learning Objective 1: 11.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.1 Solution: Although the home office is 325 square feet, the maximum square feet that one can use under the simplified method is 300. The deduction is $5 per square foot, so Atlas’s home office deduction is $1,500.

Time on Task: 2 minutes 8

2) Title: Brief Exercise 2 Difficulty: Easy Learning Objective 1: 11.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.2 Solution: Because the activity is considered a hobby, Jenna must report all her income of $3,300 as other income on her tax return. She cannot deduct any of the expenses of $2,000.

Time on Task: 2 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 11.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.3 Solution: The Utah property is rental property because Wyatt spends only 10 days vacationing at the Utah property and at least one day was rented at fair market value. Wyatt must report all his rental income of $21,500 on Schedule E, page 1. His direct rental expenses are deductible against his rental income. Wyatt must allocate his remaining expenses between rental and nonrental use based on the total number of days the property was used.

Rental income Less: Direct expenses Remaining rental income Less: Property taxes ($4,500 × 215/225 days) Less: Mortgage interest expense ($9,400 × 215/225 days) Remaining rental income Less: Utilities ($2,400 × 215/225 days) Rental income (loss) Less: MACRS Depreciation ($10,000 × 215/225) Net rental income (loss)

$21,500 ( 6,000) $15,500 ( 4,300) ( 8,982) $ 2,218 ( 2,293) ($ 75) ( 9,556) ($ 9,631)

Wyatt’s remaining real estate taxes of $200 are deductible as an itemized deduction, but his remaining mortgage interest expense of $418 is not deductible as an itemized deduction because Wyatt does not meet the minimum personal use required for the deduction.

Time on Task: 8 minutes 4) 9

Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 11.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.4 Solution: Athena is at-risk for losing her $6,500 cash she invested plus 20% of the recourse debt, $2,000.

Her total at-risk amount is $8,500. The nonrecourse debt is not allocated to Athena and does not affect her at-risk amount.

Time on Task: 4 minutes 5) Title: Brief Exercise 5 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.5 Solution: Dennis can deduct his passive loss to the extent of passive income. His adjusted gross income after the passive activities is $65,000 ($65,000 + $26,000 − $26,000). Dennis can carry forward the remaining passive activity loss of $2,000.

Time on Task: 4 minutes 6) Title: Brief Exercise 6 Difficulty: Medium Learning Objective 1: 11.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 11.6 Solution: Jaque’s basis in his partnership interest is $5,000, consisting of $2,000 cash and $3,000 basis in the property contributed. $5,000 of his partnership loss clears the basis hurdle. His at-risk amount is also $5,000 so the $5,000 loss clears the at-risk hurdle. Therefore, he can deduct $5,000 and the remaining loss of $1,000 is carried forward.

Time on Task: 6 minutes Application Problems 1) Title: Application Problem 1 10

Difficulty: Medium Learning Objective 1: 11.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.1 Solution: a. Julian can deduct home office expenses because he used the home office exclusively and regularly for business. b. Because Clayton does not use the home office exclusively and regularly for business, no home office deduction is allowed. c. Because Alicia is an employee, no home office deduction is allowed. d. Yes, Marcy can deduct a home office deduction because her basement was used for business purposes as a day care center.

Time on Task: 8 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 11.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.1 Solution: a.

Business income Less: Other business expenses Net income before home office expenses Less: Allocable real estate taxes ($7,200 × 10%) Allocable mortgage interest ($13,600 × 10%)

$53,000 ( 33,000) $20,000

Less: Allocable residential operating expenses ($6,600 × 10%) Net income before depreciation Less: Allocable MACRS depreciation Net income from business after all deduction

( 720) ( 1,360) $17,920 ( 660) $17,260 ( 1,500) $ 15,760

Sebastian’s home office deduction is $4,240 ($720 + $1,360 + $660 + $1,500) and his net income is $15,760. He can deduct the remaining real estate taxes of $6,480 ($7,200 − $720) and mortgage interest of $12,240 ($13,600 − $1,360) as itemized deductions. b.

Business income Less: Other business expenses Net income before home office expenses 11

$53,000 ( 33,000) $20,000

Less: Home office deduction (300 sq feet × $5) Net income from business after all deductions

( 1,500) $18,500

Although the home office is 375 square feet, the maximum square feet that Sebastian can use under the simplified method is 300. He can deduct $5 per square foot. Sebastian’s home office deduction is $1,500 and his net income is $18,500. He can also deduct all his real estate taxes of $7,200 and mortgage interest of $13,600 as itemized deductions. He does not have to reduce the basis of his house for depreciation claimed because the simplified method assumes that depreciation deducted is zero.

Time on Task: 12 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 11.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.1 Solution: a.

Business income Less: Other business expenses Net income before home office expenses Less: Allocable real estate taxes ($5,200 × 15%) Less: Allocable mortgage interest ($8,300 × 15%) Less: Allocable residential operating expenses ($4,300 × 15%) Net income before depreciation *Less: Allocable MACRS depreciation ($1,000) Net income from business after all deductions

$28,000 ( 25,000) $ 3,000 ( 780) ( 1,245) $ 975 ( 645) $ 330 ( 330) $ 0

*A home office deduction cannot create a loss, so the depreciation is limited to the remaining income available of $330. Cameron can carryforward the unused portion of the MACRS depreciation of $670. Cameron’s home office deduction is $3,000 and his net income is $0. He can deduct the remaining real estate taxes of $4,420 and mortgage interest of $7,055 as itemized deductions. b. Business income Less: Other business expenses Net income before home office expenses Less: Home office deduction (300 sq feet × $5) Net income from business after all deductions

$28,000 ( 25,000) $ 3,000 ( 1,500) $ 1,500

Although the home office is 450 square feet, the maximum square feet that Cameron can use under the simplified method is 300. He can deduct $5 per square foot. Cameron’s 12

home office deduction is $1,500 and his net income is $1,500. He can also deduct all his real estate taxes of $5,200 and mortgage interest of $8,300 as itemized deductions. He does not have to reduce the basis of his house for depreciation claimed because the simplified method assumes that depreciation deducted is zero.

Time on Task: 12 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 11.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.1 Solution: To claim a home office deduction on your tax return, the office must be used exclusively for business on a continuous, regular basis. Dontrell meets these requirements, but Mavis does not.

Because their children also use the second bedroom, Mavis cannot deduct any home office deduction. Dontrell will deduct $1,125 (225  $5) as a home office deduction.

Time on Task: 5 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 11.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.2 Solution: a. If the jewelry making is treated as a business, Kerry will be able to report a loss on his Schedule C of $650 ($5,800 − $6,450). b. If the jewelry making is treated as a hobby, then Kerry must report his income of $5,800 as other income on his Form 1040, and he is not allowed a deduction for his expenses.

Time on Task: 4 minutes 6) Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 11.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.2 Solution:

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It is in June’s best interest to offer the training courses and earn the income to generate the small profit in 2024. The tax law provides a presumption that an activity is profit-seeking if the activity shows a profit in at least three of the previous five years. Because June had a profit in 2020 and 2021, a profit in 2024 would satisfy this rule. June would be able to deduct the losses generated in the other years on Schedule C as a profit-seeking activity. If the IRS chooses to challenge the presumption and make the case that the activity is a personal hobby, it has the burden of proof to prove that the activity is a personal hobby.

Time on Task: 4 minutes 7) Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 11.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.3 Solution: The Florida property is considered a residence with minimal rental use because Nomar rents it for only 14 days and he lives in it for at least 15 days. Nomar can exclude the rental income of $2,800 (14 days × $200) and he cannot deduct any expenses related to the rental. Nomar can claim as an itemized deduction the real estate taxes paid of $2,600 and the mortgage interest expense paid of $5,550. No Schedule E, page 1 is needed for this property.

Time on Task: 4 minutes 8) Title: Application Problem 8 Difficulty: Medium Learning Objective 1: 11.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.3 Solution: The Texas property is a rental property because Dean spends only 14 days vacationing at the Texas property and at least one day was rented at fair market value. Dean must report all his rental income of $52,725 (285 days × $185) on Schedule E, page 1. His direct rental expenses are deductible against his rental income. The depreciable basis of the property is $300,000 ($330,000 cost − $30,000 land allocation). The property is depreciated straight-line over 27.5 years. Dean must allocate his remaining expenses between rental and nonrental Rental income ($185 × 285 days) Less: Advertising (direct) Less: Realtor commissions (direct) Remaining rental income Less: Real estate taxes ($3,800 × 285/299 days) 14

$52,725 ( 1,000) ( 1,200) $50,525 ( 3,622)

Less: Mortgage interest expense ($7,400 × 285/299 days) Remaining rental income Less: Utilities ($20 × 285) Less: Insurance ($4 × 285) Less: Association dues ($10 × 285) Remaining rental income Less: MACRS Depreciation ($300,000/27.5 × 285/299) Net rental income

( 7,054) $39,849 ( 5,700) ( 1,140) ( 2,850) $30,159 ( 10,398) $ 19,761

Dean’s remaining real estate taxes of $178 ($3,800 − $3,622) are deductible as an itemized deduction, but his remaining mortgage interest expense of $346 ($7,400 − $7,054) is not deductible as an itemized deduction because Dean does not meet the minimum personal use required for the deduction.

[COMP: High-res PDF for the below has been submitted; see file "Carnes_I2025_Ch11_SM_AP_8_Form 1040 Sch E 2023 James.pdf"]

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Time on Task: 15 minutes 9) 16

Title: Application Problem 9 Difficulty: Medium Learning Objective 1: 11.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.3 Solution: The Arizona property is a residence with significant rental use (personal/rental). The Arizona home qualifies as a residence because April used the home for personal purposes (200 days) for more than the greater of 14 days or 10% of the number of rental days (100 days) during the year.

April must report all her rental income of $22,500 ($225 × 100 days) on Schedule E, page 1. Her direct rental expenses are deductible against rental income. April must allocate her remaining expenses between rental and nonrental. The depreciable basis of the property is $250,000 ($280,000 cost − $30,000 land allocation). The property is depreciated straight-line over 27.5 years. The personal use allocation of Tier 1 expenses (mortgage interest and property taxes) is deductible on Schedule A. The personal use allocation of Tier 2 expenses (other) and Tier 3 expenses (depreciation) are not deductible. a. Tax Court Method The Tax Court method allocates real estate taxes and mortgage interest based on the total days in the tax year.

Rental income ($225 × 100 days) Less: Advertising (direct) Less: Realtor commissions (direct) Remaining rental income Less: Real estate taxes ($2,600 × 100/365 days) Less: Mortgage interest expense ($5,550 × 100/365 days) Remaining rental income Less: Utilities ($10 × 100) Less: Insurance ($3 × 100) Less: Association dues ($9 × 100) Remaining rental income Less: MACRS Depreciation ($250,000/27.5 × 100/300) Net rental income

$22,500 ( 1,000) ( 1,200) $20,300 ( 712) ( 1,521) $18,067 ( 1,000) ( 300) ( 900) $15,867 ( 3,030) $ 12,837

[COMP: High-res PDF for the below has been submitted; see file "Carnes_I2025_Ch11_SM_AP_9_Form 1040 Sch E 2023 Heir Tax Court method.pdf"]

17

b. IRS Method 18

The IRS method allocates mortgage interest and property taxes based on the total numbers of days that the property is used, which is 300 days for this property (200 + 100).

Rental income ($225 × 100 days) Less: Advertising (direct) Less: Realtor commissions (direct) Remaining rental income Less: Real estate taxes ($2,600 × 100/300 days) Less: Mortgage interest expense ($5,550 × 100/300 days) Remaining rental income Less: Utilities ($10 × 100) Less: Insurance ($3 × 100) Less: Association dues ($9 × 100) Remaining rental income Less: MACRS Depreciation ($250,000/27.5 × 100/300) Net rental income

$22,500 ( 1,000) ( 1,200) $ 20,300 ( 867) ( 1,850) $ 17,583 ( 1,000) ( 300) ( 900) $ 15,383 ( 3,030) $ 12,353

[COMP: High-res PDF for the below has been submitted; see file "Carnes_I2025_Ch11_SM_AP_9_Form 1040 Sch E 2023 Heir IRS method.pdf"]

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Time on Task: 16 minutes 20

10) Title: Application Problem 10 Difficulty: Medium Learning Objective 1: 11.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.3 Solution: The Georgia property is a residence with significant rental use (personal/rental). The Georgia home qualifies as a residence because Wes used the home for personal purposes (45 days) for more than the greater of 14 days or 10% of the number of rental days (100 days) during the year.

Wes must report all his rental income of $16,500 ($165 × 100 days) on Schedule E, page 1. His direct rental expenses are deductible against rental income. Wes must allocate his remaining expenses between rental and nonrental. Expenses can reduce income down to zero, but the expenses cannot create a loss. The depreciable basis of the property is $175,000 ($195,000 cost − $20,000 land allocation). The property is depreciated straight-line over 27.5 years. The personal use allocation of Tier 1 expenses (mortgage interest and property taxes) is deductible on Schedule A. The personal use allocation of Tier 2 expenses (other) and Tier 3 expenses (depreciation) are not deductible.

IRS Method The IRS method allocates mortgage interest and property taxes based on the total number of days that the property is used, which is 145 days for this property (45 + 100).

Rental income ($165 × 100 days) Less: Advertising (direct) Less: Realtor commissions (direct) Remaining rental income Less: Real estate taxes ($5,360 × 100/145 days) Less: Mortgage interest expense ($9,400 × 100/145 days) Remaining rental income Less: Utilities ($22 × 100) Less: Insurance ($5 × 100) Less: Association dues ($10 × 100) Remaining rental income Less: MACRS Depreciation ($175,000/27.5 × 100/145) $4,389 Net rental income

$16,500 ( 800) ( 1,000) $14,700 ( 3,697) ( 6,483) $ 4,520 ( 2,200) ( 500) ( 1,000) $ 820 ( 820) $ 0

The remaining depreciation expense of $3,569 ($4,389 − $820) is carried forward and used against future rental income.

Time on Task: 10 minutes 11) Title: Application Problem 11 Difficulty: Medium 21

Learning Objective 1: 11.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.3 Solution: Sterling may deduct his rental expenses on his rental property. He does not have a mixed-use property; Sterling has a pure rental property. Even though no income was generated, the intent to earn rental income is substantiated by listing on VRBO. Therefore, Sterling can deduct his rental expenses on Schedule E, page 1.

Time on Task: 5 minutes 12) Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 11.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.4 Solution: Tamika is at-risk for $12,000 cash, plus $180,000 adjusted basis of the building plus 30% of the recourse debt which is $10,800 ($36,000 × 30%). Her total at-risk amount is $202,800.

Time on Task: 4 minutes 13) Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 11.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.4 Solution: Nuan is at-risk for $62,000 cash, plus 30% of the recourse debt which is $42,000 ($140,000 × 30%), plus 30% of the qualified nonrecourse debt which is $66,000 ($220,000 × 30%). Qualified nonrecourse financing secured by the real property used in the activity is included in the at-risk amount for owners of real estate activities. Total at-risk amount is $170,000.

Time on Task: 4 minutes 14) Title: Application Problem 14 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting 22

Standard 3: Bloom's || Application Section Reference 1:11.5 Solution: Delroy’s income from the LLC is passive because he does not materially participate. Limited partnership interests are passive. Delroy can offset passive losses to the extent of passive income.

Delroy’s adjusted gross income is $125,000 ($125,000 + $32,000 − $32,000). The remaining passive loss of $12,000 is suspended and carried forward indefinitely.

Time on Task: 5 minutes 15) Title: Application Problem 15 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.5 Solution: Kirby will report a gain of $55,000.

Amount realized Less: Adjusted basis Total gain Less: Suspended PAL Taxable passive gain Time on Task: 5 minutes

$350,000 ( 235,000) $115,000 ( 60,000) $ 55,000

16) Title: Application Problem 16 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.5 Solution: a. Amount realized Less: Adjusted basis Total gain Less: Suspended PAL Deductible loss (not passive)

$140,000 ( 100,000) $ 40,000 ( 55,000) ($ 15,000)

The $15,000 deductible loss can offset Jose’s active and portfolio income. b. Amount realized Less: Adjusted basis

$ 90,000 (100,000) 23

Total gain/(loss) Less: Suspended PAL Deductible loss (not passive)

($10,000) ( 55,000) ($65,000)

Jose's loss on the sale is $10,000 and the overall deductible loss is $65,000. This total loss, including the suspended PAL, is deductible as a nonpassive activity loss.

Time on Task: 8 minutes 17) Title: Application Problem 17 Difficulty: Difficult Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.5 Solution: Activity ABC ($14,000) Activity DEF ( 8,000) Activity GHI 10,000 Net passive activity loss ($12,000) $10,000 of passive losses can offset the passive income from Activity GHI. The total passive losses are $22,000 ($14,000 + $8,000). The $10,000 passive loss deduction is allocated as follows:

Activity ABC ($10,000 × $14,000/$22,000) Activity DEF ($10,000 × $8,000/$22,000) Total passive loss deduction

Deduct ($ 6,364) ( 3,636) ($10,000)

Suspend ($ 7,636) ( 4,364) ($12,000)

Time on Task: 6 minutes 18) Title: Application Problem 18 Difficulty: Difficult Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.5 Solution: To calculate Chrissy’s adjusted gross income, you first compute her net rental gain or loss as follows: Rental real estate activity (Actively participates) 24

($ 75,000)

Rental real estate activity (Actively participates) Net rental loss (passive)

40,000 ($ 35,000)

Chrissy can offset the $20,000 of passive income with $20,000 of the rental real estate losses.

This leaves $15,000 of the rental real estate losses. Because her AGI does not exceed $100,000 and she actively participates in the rental real estate activities, she can use up to $25,000 of rental real estate losses to offset active or portfolio income. Thus, the $15,000 of rental real estate losses can reduce her AGI. Chrissy’s AGI is $85,000 − $15,000 = $70,000.

Time on Task: 8 minutes 19) Title: Application Problem 19 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.5 Solution: Because Dicky’s AGI exceeds $100,000, some of his $25,000 rental real estate loss benefit is phased out as follows: Current AGI Less: Threshold Excess Phaseout

$110,000 ( 100,000) $ 10,000 × 50% $ 5,000

Maximum benefit Less: Phaseout Deductible

$25,000 ( 5,000) $20,000

Dicky can deduct $20,000 of his rental real estate loss and $12,000 ($32,000 − $20,000) will be a suspended passive activity loss. Dicky’s AGI is $110,000 − $20,000 = $90,000.

Time on Task: 6 minutes 20) Title: Application Problem 20 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.5 Solution:

25

a. Randy does materially participate because the activity is a personal service activity in which he materially participated for any 3 preceding tax years. b. Dominique does materially participate because she participates in the activity for more than 100 hours during the tax year, and the participation is at least as much as any other individual for the year. c. Adeline does not materially participate because she does not work more than 500 hours and she does not work more than any other participant. d. Felix does materially participate because he materially participated in the activity for any 5 of the 10 immediately preceding tax years.

Time on Task: 8 minutes 21) Title: Application Problem 21 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.5 Solution: Liz calculates her gain after using the suspended passive activity losses: Gain on sale $50,000 Less: Suspended PAL ( 18,000) Taxable gain $32,000 Marginal rate × 22% Tax on passive gain $ 7,040 Less: Passive credits ( 7,040) Net tax $ 0 The remaining passive activity credits of $960 ($8,000 − $7,040) are carried forward to be used against future tax liability from other passive activities.

Time on Task: 8 minutes 22) Title: Application Problem 22 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.5 Solution: a. None of the suspended loss is deductible on Blake’s final return or by the beneficiary because the suspended loss of $8,200 does not exceed the step-up in basis to fair market value at death of $15,000 ($37,000 − $22,000).

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b. Because the step-up in basis to fair market value at death is only $5,000 ($27,000 − $22,000), the suspended loss allowed is limited to $3,200 ($8,200 − $5,000). The suspended loss of $3,200 is deducted on Blake’s final income tax return.

Time on Task: 6 minutes 23) Title: Application Problem 23 Difficulty: Difficult Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.5 Solution: First, we must determine if Beau is a real estate professional. His total hours working in trades or businesses this year is: Real estate agent Skating rink Shopping centers Total

900 400 600 1,900

Beau’s total time working in real estate trades or businesses is 1,500 hours, which is more than 750 hours. He spent 78.9% of his time working in real estate trades or businesses (1,500 ÷ 1,900) so Beau also meets the 50% test. Therefore, he is a real estate professional.

If Beau elects to treat the shopping centers as one activity, then the total time devoted to rental real estate was 600 hours. Because this is more than 500 hours, Beau did materially participate.

Therefore, the total loss from the rental real estate activities of ($42,500) is not passive and can offset active income and portfolio income on Beau’s tax return.

Time on Task: 8 minutes 24) Title: Application Problem 24 Difficulty: Medium Learning Objective 1: 11.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.6 Solution: Miguel cannot deduct any of the $13,500 loss. Only $10,000 of the loss clears the basis hurdle and $8,200 clears the at-risk hurdle. Because the $8,200 is a passive loss and Miguel does not have any passive income, he cannot deduct the loss.

Time on Task: 5 minutes 27

25) Title: Application Problem 25 Difficulty: Medium Learning Objective 1: 11.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1:11.6 Solution: Fynn’s Beginning basis $ 18,900 Less: Year 1 loss deducted ( 18,900) Basis December 31, Year 1 $ 0 Year 2 income 22,000 Less: Suspended loss deducted ( 21,100) Basis December 31, Year 2 $ 900 Time on Task: 6 minutes

Suspended loss of $21,100

Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Medium Learning Objective 1: 11.2 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 11.2 Solution: The regulations indicate nine factors that Albert should consider in determining if the activity is profit-seeking or is a hobby: 1. Is the activity carried on like a business, such as having a separate checking account, an employer identification number (EIN) assigned by the IRS, a social media presence, and business cards?

2. Does the business operator have the knowledge and skills necessary to be successful in this business?

3. How much time and effort does the individual spend on the activity?

4. Is there an expectation that some of the assets used in the activity will increase in value? (This factor applies primarily to real estate and investment activities.)

5. If the activity has a history of losses, has the operator been successful with creating profits for similar ventures in the past?

6. What has the history of losses and profits been from the activity?

7. What is the relative amount of profits and losses for the activity from one year to the next?

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8. What is the relative amount of income the taxpayer earns from this activity in comparison to other sources of income?

9. Does the activity have recreational appeal for the taxpayer?

Albert needs to meet as many of these factors as possible in favor of a profit seeking activity. He should increase his time expended on the horse farm. He should have an EIN for the farm and a separate checking account. He should set up a website and begin marketing the services provided.

Time on Task: 8 minutes 2) Title: Tax Planning Problem 2 Difficulty: Difficult Learning Objective 1: 11.3 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 11.3 Solution: The California property is a residence with significant rental use (personal/rental). The California home qualifies as a residence because Yoon used the home for personal purposes (62 days) for more than the greater of 14 days or 10% of the number of rental days (145) during the year.

Yoon must report all her rental income of $31,175 ($215 × 145 days) on Schedule E, page 1. Her direct rental expenses are deductible against rental income. Yoon must allocate her remaining expenses between rental and nonrental. The depreciable basis of the property is $360,000 ($400,000 cost − $40,000 land allocation). The property is depreciated straight-line over 27.5 years.

We next evaluate if it would be better for Yoon to use the Tax Court method or the IRS approach when allocating her real estate taxes and mortgage interest expense.

Tax Court Method The Tax Court method allocates the real estate taxes and mortgage interest based on the total days in the tax year.

Rental income ($215 × 145 days) Less: Advertising (direct) Less: Realtor commissions (direct) Remaining rental income Less: Real estate taxes ($7,300 × 145/365 days) Less: Mortgage interest expense ($14,250 × 145/365 days Remaining rental income Less: Utilities ($15 × 145) Less: Insurance ($5 × 145) Remaining rental income Less: MACRS Depreciation ($360,000/27.5 × 145/207) 29

$ 31,175 ( 1,800) ( 2,400) $ 26,975 ( 2,900) ( 5,661) $ 18,414 ( 2,175) ( 725) $ 15,514 ( 9,170)

Net rental income

$

6,344

IRS Method The IRS method allocates mortgage interest and property taxes based on the total number of days that the property is used, which is 207 days for this property (62 + 145).

Rental income ($215 × 145 days) $ 31,175 Less: Advertising (direct) ( 1,800) Less: Realtor commissions (direct) ( 2,400) Remaining rental income $ 26,975 Less: Real estate taxes ($7,300 × 145/207 days) ( 5,114) Less: Mortgage interest expense ($14,250 × 145/207 days) ( 9,982) Remaining rental income $ 11,879 Less: Utilities ($15 × 145) ( 2,175) Less: Insurance ($5 × 145) ( 725) Remaining rental income $ 8,979 Less: *MACRS Depreciation ($360,000/27.5 × 145/207) ( 8,979) Net rental income $ 0 *The depreciation of $9,170 is limited to $8,979 because Yoon cannot recognize a loss.

The total deductions allowed under the Tax Court approach is:

Real estate taxes Mortgage interest exp Advertising Realtor commissions Utilities Insurance Depreciation Total

For AGI $ 2,900 5,661 1,800 2,400 2,175 725 9,170 $ 24,831

Itemized deduction $4,400 8,589

Total

$12,989

$37,820

The total deductions allowed under the IRS approach is:

Real estate taxes Mortgage interest exp Advertising Realtor commissions Utilities Insurance Depreciation Total

For AGI $ 5,114 9,982 1,800 2,400 2,175 725 8,979 $31,175

Itemized deduction $2,186 4,268

Total

$6,454

$37,629

The difference between the two totals is attributable to the reduction of the depreciation expense by $191 under the IRS approach which will be carried forward and hopefully used next year.

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However, as long as Yoon is able to itemize her deductions, she should choose the IRS approach because her deductions for AGI are greater under the IRS approach and result in no income from the property being recognized above the line in the current year. In addition, if AGI is lower, then items that are phased out based on AGI will not be impacted to the same degree.

Time on Task: 20 minutes 3) Title: Tax Planning Problem 3 Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 11.5 Solution: Atticus should be concerned that the number of hours he is working is not sufficient and the IRS could treat the activity as passive. Because the average period of customer use is seven days or less, the business is not automatically treated as a rental activity. For the loss to not be passive, he must still materially participate in the business. Atticus needs to perform at least 500 hours of work for the loss to not be passive.

Time on Task: 5 minutes Communication Problem 1) Title: Communication Problem: Business Activity or Hobby?

Difficulty: Medium Learning Objective 1: 11.2 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 11.2 Solution: Memo to Client Hello Norma, Based on the information provided, you are a crafter, and your activity is considered a hobby.

Under the hobby rules, you must include the $1,900 of revenue as other income on your tax return and you cannot deduct the hobby expenses under current law. Typically, you could have offset cost of goods sold against gross income, but because no receipts and records were kept, you cannot deduct anything. If you would like to discuss how this activity can become a profitseeking activity, I am more than happy to meet with you and discuss these rules further.

Sincerely, 31

Carnes & Youngberg CPAs Tax memo to the file Facts: Norma included receipts for craft expenses in her current year tax information of $2,150.

Upon asking Norma additional questions, you realize that she did not keep any accounting records, did not collect any sales tax, and does not intend the activity to be a business. Norma also collected $1,900 in gross revenue from sales at the craft show.

Issue: Can Norma deduct her net loss of $250?

Conclusion: Norma cannot deduct the net loss of $250. She must include the gross revenue of $1,900 as other income on her tax return and cannot deduct the craft expenses. Typically, a taxpayer could have cost of goods sold against gross income, but because Norma kept no receipts and records, she cannot deduct anything.

Analysis: According to IRC §183, beginning in 2018, the IRS doesn't allow a taxpayer to deduct hobby expenses from hobby income. A taxpayer must include all hobby income as other income and they are not permitted to reduce that income by any expenses. For tax years prior to 2018, a taxpayer can deduct hobby expenses as an itemized deduction subject to 2% of adjusted gross income to the extent the expenses do not exceed hobby income.

Time on Task: 10 minutes Ethics Problem 1) Title: Ethics Problem: Rental of Personal Residence Difficulty: Medium Learning Objective 1: 11.3 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 11.3 Solution: AICPA Statement on Standards for Tax Services No. 2.1.6, Tax Return Positions, states "A member should determine and comply with the standards, if any, that are imposed by the applicable taxing authority with respect to preparing or signing a tax return." Because you know of the omission, you should not sign the tax return and advise Dexter that the $4,500 should be included on the return. Circular 230 §10.21 Knowledge of client’s omission states that the tax accountant “must advise the client promptly of the fact of such noncompliance, error, or omission. The practitioner must advise the client of the consequences including penalties and interest.”

Time on Task: 10 minutes Research Problems

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1) Title: Research Problem 1: Home Office Deduction Difficulty: Medium Learning Objective 1: 11.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 11.1 Solution: Under IRC §280A(c)(1)(A) & (B), expenses attributable to a portion of a dwelling unit will qualify for a home office deduction if the portion is used regularly and exclusively as a principal place of business or as a place of business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of business. Under IRC §280A(f)(1) dwelling unit includes a house, apartment, condominium, mobile home, boat, or similar property, and all structures or other property appurtenant to such dwelling unit. Expenses deductible for a home office include rent, depreciation, mortgage interest, property taxes, casualty losses, utilities, insurance, and repairs.

Time on Task: 8 minutes 2) Title: Research Problem 2: Vacation Home/Rental Property: Determining Personal Use Days Difficulty: Hard Learning Objective 1: 11.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 11.3 Solution: Under IRC §280A(d)(2), personal use is defined as use by the taxpayer or any other person who has an interest in such unit, or by any member of the family (as defined by §267(c)(4)) of the taxpayer or such other person. However, Prop. Reg. §1.280A-1(e)(2) states a taxpayer shall not be treated as using a dwelling unit for personal purposes by reason of a rental arrangement for any day on which the taxpayer rents the dwelling unit at a fair rental to any person for use as that person's principal residence. Because Driss’s brother paid fair rental value and Driss did not have access to the unit, those seven days will not be considered personal use days for Driss. Driss’ sister’s five days will be considered personal use days for Driss because she did not pay any rent.

Under Prop. Reg. §1.280A-1(e)(6), repair and maintenance days are not considered personal use days for which the principal purpose is to make repairs and not pleasure. The principal purpose test will be determined based on facts and circumstances including, but not limited to, the following: the amount of time devoted to repair and maintenance work, the frequency of the use for repair and maintenance purposes during a taxable year, and the presence and activities of companions. Because Driss’s family was not with him on his three repair and maintenance days, those days will not be considered personal use days.

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Driss has 12 personal use days (7 personal days with his family and 5 days that his sister uses the property). Because his 12 personal use days are less than 14, his vacation home is considered a rental property.

Time on Task: 15 minutes Excel Problem 1) Title: Excel Problem: Rental Loss Deduction Difficulty: Medium Learning Objective 1: 11.5 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 11.5 Solution: Scenario A: Marco can deduct the $18,000 rental loss on his tax return. His AGI is under $100,000 and his loss is less than $25,000.

Scenario B: Marco can deduct $20,000 of the loss on his tax return. His AGI is above $100,000 but less than $150,000 so the $25,000 rental loss limit is partially phased out.

AGI Less: Threshold Excess Phaseout

$110,000 ( 100,000) $ 10,000 50% $ 5,000

Rental loss limit available Less: Phaseout Allowable rental loss

$ 25,000 ( 5,000) $ 20,000



Of the $30,000 rental loss, Marco can deduct $20,000. The remaining $10,000 loss will be carried forward as a suspended PAL. Scenario C: Marco cannot deduct the $22,000 rental loss because his AGI exceeds $150,000 and the availability of the $25,000 rental loss limit is completely phased out.

Input Area: Adjusted Gross Income Rental Loss

(18,000)

Calculation: Deductible Rental Loss

(18,000)

85,000

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Input Area: Adjusted Gross Income Rental Loss

85,000 -18,000

Calculation: =-MIN(25000-MIN(IF(B4>100000,B4-100000,0)*0.5,25000),B5)

Deductible Rental Loss Time on Task: 12 minutes CPA Exam Preparation: Task-Based Simulation

1) Title: Task-Based Simulation: Excess Business Loss Limitation Difficulty: Hard Learning Objective 1: 11.1, 4-6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 11.1, 4-6 Solution: To revise the document, click on each segment of underlined text below and select the needed correction, if any, from the list provided. If the underlined text is already correct in the context of the document, select [Original text] from the list.

BBC deductible loss 1. The amount of deductible loss from BBC, LLC is $40,000.

[Original text] The amount of deductible loss from BBC, LLC is $40,000.

The amount of deductible loss from BBC, LLC is $35,000.

The amount of deductible loss from BBC, LLC is $30,000.

The amount of deductible loss from BBC, LLC is $10,000.

The amount of deductible loss from BBC, LLC is $0.

A partnership loss on the Schedule K-1 can be deducted on the partner’s tax return to offset other income. The loss deductibility can be limited for several reasons. When limitations apply, all or a portion of the loss is suspended. Three different limitations may apply: 1. Overall basis limitation. A loss is deductible only to the extent of basis in the partnership interest.

2. Losses that are deductible under #1 are then subject to the at-risk limitations. Losses are deductible under this provision only to the extent that a partner is at risk for the partnership interest.

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3. Losses that are deductible under #1 and #2 must meet a third requirement if the loss is passive. Passive losses are deductible only to the extent of passive income.

Bert had a $40,000 loss from BBC on his Schedule K-1.

Limitation Overall basis At-risk limit Passive limit*

Deductible loss $35,000 $30,000

Suspended loss $5,000 $5,000

*Not applicable because Bert is not a passive investor. Therefore, Bert may deduct $30,000 on his Form 1040.

Passive investment in BBC 2. If Bert Becker is a passive investor in BBC, has a basis in the LLC of $50,000 and is at risk for $50,000, the amount of deductible loss from BBC, LLC is $50,000.

[Original text] The amount of deductible loss from BBC, LLC is $50,000.

The amount of deductible loss from BBC, LLC is $40,000.

The amount of deductible loss from BBC, LLC is $25,000.

The amount of deductible loss from BBC, LLC is $16,000.

The amount of deductible loss from BBC, LLC is $0.

Although Bert has enough basis in the LLC and at-risk basis to deduct the loss, a taxpayer can deduct passive losses only to the extent of passive income. Because Bert has no passive income, the $40,000 passive loss is suspended and carried over.

Total deductible loss for Bert 3. After reviewing all investment activities exhibits and assuming that Bert has enough basis in the LLC and partnership and at-risk basis and disregarding any potential home office deduction, the total deductible business loss for Bert is $250,000 [Original text] The total deductible business loss for Bert is $250,000.

The total deductible business loss for Bert is $305,000.

The total deductible business loss for Bert is $308,600.

The total deductible business loss for Bert is $310,000.

The total deductible business loss for Bert is $540,000.

In addition to the limitations already discussed, a fourth limitation applies to the total amount of business loses that a taxpayer can deduct. Business losses are limited to $305,000 (2024) for single and head of household taxpayers and $610,000 (2024) for married filing jointly. Any remaining loss can be carried forward as part of the taxpayer’s net operating loss.

Activity

Loss 36

BBC, LLC MaryJane Partnership Mile High Schedule C Net loss Loss limit Excess loss

($ 40,000) ( 270,000) 1,400 ($308,600) 305,000 ($ 3,600)

Home office deduction 4. After reviewing Bert’s home expenses schedule and Schedule C for Mile High Outfitters and ignoring any allowable depreciation expenses for the home office, the allowable home office deduction is $3,000.

[Original text] The allowable home office deduction is $3,000.

The allowable home office deduction is $2,539.

The allowable home office deduction is $1,400.

The allowable home office deduction is $1,000.

The allowable home office deduction is $0.

A home office deduction is allowed for a home office used regularly and exclusively as a place of business for the taxpayer’s trade or business, or as a place to meet with patients, clients, or customers in the normal course of business. Qualified expenses include direct expenses of maintaining the home office and indirect expenses of maintaining the home. Indirect expenses are allocated based on the square footage of the office divided by the total square footage of the home.

Home expenses Mortgage interest expense $6,000 Real estate taxes 2,500 Gas bill 1,200 Electric bill 1,800 Homeowners insurance 1,600 Total $13,100  550/3000 = $2,402 The $2,402 is limited to the net profit from Schedule C before the home office deduction.

Therefore, the allowable amount of home office deduction is $1,400. Groceries are not a deductible expense. The taxpayer can carry forward disallowed home office expenses and use them in future years when business income is sufficient.

Time on Task: 25 minutes

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Chapter 12—Taxation of Investment Income End of Chapter Solutions Discussion Questions  1) Title: Discussion Question 1 Difficulty: Easy Learning Objective 1: 12.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.1 Solution: A municipal bond is a bond issued by state or local governments and possessions of the United States such as Puerto Rico, the U.S. Virgin Islands and Guam. The tax law excludes this interest income from gross income to allow states and municipalities to finance their long-term projects at a lower cost. Typically, they are lower in risk than corporate bonds but with a lower rate of return.

Time On Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Medium Learning Objective 1: 12.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.1 Solution: The guidelines for excluding interest on Series EE savings bonds when received at maturity or redemption if the taxpayer uses the proceeds to pay qualified higher-education expenses in that year are as follows: • The exclusion is available if the owner of the bond was at least 24 years old at the time the individual purchased the bond.

• The owner of the bond must use the bond proceeds to pay higher education expenses for the taxpayer or the taxpayer’s spouse or dependent.

The owner excludes the interest income in proportion to the qualified higher education expenses that are not reimbursed by scholarships to the total funds received.

Time On Task: 4 minutes 3) Title: Discussion Question 3 Difficulty: Easy Learning Objective 1: 12.1 Standard 1: AACSB || Knowledge

1

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.1 Solution: The taxpayer reports taxable interest income on Schedule B if the taxpayer has more than $1,500 of taxable interest and/or ordinary dividend income. Otherwise, the income is reported directly on page 1 of Form 1040.

Time On Task: 1 minute 4) Title: Discussion Question 4 Difficulty: Medium Learning Objective 1: 12.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.1 Solution: Bonds are often purchased at a price that is different than their face value. This creates either a bond premium or bond discount. Premiums occur when the amount paid for the bond is more than its face value. If a taxpayer buys a taxable bond at a premium, an election can be made to amortize the premium. Discounts occur when the amount paid for the bond is less than its face value. This difference represents interest income that must be recognized in the future.

Time On Task: 3 minutes 5) Title: Discussion Question 5 Difficulty: Hard Learning Objective 1: 12.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.1 Solution: Loans made where a reduced rate or even no interest is charged to the borrower. Gift loans to family or friends, compensation-related loans, and corporation/shareholder loans are examples where a below-market loan can occur, and imputed interest rules would apply.

Time On Task: 4 minutes 6) Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 12.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge

2

Section Reference 1: 12.2 Solution: Ordinary dividends declared and paid by a corporation are includible in the recipient’s taxable income and are taxed at ordinary income rates. Ordinary dividends are reported on Schedule B if the taxpayer has more than $1,500 of taxable interest and/or ordinary dividend income and on Form 1040 page 1, line 3b. Qualified dividends are distributions from a corporation’s earnings and profits. Qualified dividend income is reported on Form 1040 page 1, line 3a. The term “qualified” indicates how the dividend will be taxed, not if the dividend will be taxed. Qualified dividend income is taxed at long-term capital gain rates (0%, 15%, or 20%), depending on the taxpayer’s taxable income and filing status. To qualify for this lower LTCG rate, taxpayers must meet two requirements: 1. Taxpayers must receive the dividend from a domestic corporation (with some exceptions for foreign corporations).

2. Taxpayers must hold the stock for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date Time On Task: 4 minutes 7) Title: Discussion Question 7 Difficulty: Medium Learning Objective 1: 12.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.2 Solution: Qualified dividend income is taxed at long-term capital gain rates, (either 0%, 15%, or 20% for individuals). Taxation of qualified dividend income is no longer tied to the taxpayer’s marginal tax rate, but rather the capital gains tax table, depending on the individual’s taxable income and filing status.

Time On Task: 2 minutes 8) Title: Discussion Question 8 Difficulty: Medium Learning Objective 1: 12.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.2 Solution: No, pro rata stock dividends do not provide the taxpayer with any increase in value and, therefore, are not taxable events. The stock dividend does not change the shareholder’s percentage interest in the corporation. Each shareholder will allocate a portion of their basis in their current shares to the newly distributed shares. The basis per share after the dividend is the original basis divided by the total number of shares held after the stock dividend.

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Time On Task: 4 minutes 9) Title: Discussion Question 9 Difficulty: Medium Learning Objective 1: 12.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.2 Solution: Date of declaration is the date a dividend is announced by the corporation. The record date is the date that a corporation determines who owns the stock for the purpose of paying the dividend.

The ex-dividend date is the day after the date of record.

Time On Task: 4 minutes 10) Title: Discussion Question 10 Difficulty: Easy Learning Objective 1: 12.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.3 Solution: A capital asset is defined as every asset whether used personally, or for investment, or in a trade or business except: a. Inventory b. Accounts and Notes Receivable c. Depreciable assets and realty used in a business. d. Creative works (in the hands of the creator) e. Certain miscellaneous assets (such as government publications or obligations) Time On Task: 3 minutes 11) Title: Discussion Question 11 Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution:

4

The Lewises may use $3,000 of the net capital loss against ordinary income in the current year.

The Lewises can carry forward the remaining capital loss of $3,200 indefinitely to offset against future capital gains and ordinary income (limited to $3,000 per year).

Time On Task: 4 minutes 12) Title: Discussion Question 12 Difficulty: Easy Learning Objective 1: 12.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.3 Solution: The current preferential rates available for individuals on long-term capital gains and qualified dividend income are 0%, 15%, and 20% depending on the level of taxable income.

Time On Task: 2 minutes 13) Title: Discussion Question 13 Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.3 Solution: Collectibles are taxed at a maximum of 28%. Collectibles are tangible personalty such as coins, art, and antiques purchased for investment purposes. Gold and silver are also classified as collectibles subject to the 28% rate. Because the taxpayer’s ordinary income rate is 32%, the maximum rate applied to the collectible will be 28%.

Time On Task: 4 minutes 14) Title: Discussion Question 14 Difficulty: Hard Learning Objective 1: 12.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.3 Solution: Robert must hold the qualified small business stock for at least 5 years to qualify for the 100% exclusion. So, Robert must not sell before November 1, 2024.

Time On Task: 3 minutes

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15) Title: Discussion Question 15 Difficulty: Medium Learning Objective 1: 12.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.4 Solution: A 3.8% net investment income tax applies to taxpayers whose modified AGI exceeds $200,000 if single or head of household or $250,000 if married filing jointly. The 3.8% tax applies to the lesser of (a) net investment income, or (b) the excess of modified AGI over the modified AGI thresholds. Therefore, the highest tax rate that applies to net investment income for a single individual is 23.8% (20% + 3.8%).

Time On Task: 3 minutes Multiple Choice Questions 1) Answer: b Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 12.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.1 Solution: The correct answer is Interest received on state and local bonds.

Interest received on state and local bonds (municipal bonds) is excluded from income on the federal income tax return. Interest received on corporate bonds, state income tax refunds and U.S. government bonds are all taxable.

Time On Task: 2 minutes 2) Answer: c Title: Multiple Choice Question 2 Difficulty: Medium Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.1 Solution: The correct answer is $1,250.

Local government bonds are municipal bonds, and therefore the interest earned is tax-exempt.

6

Time On Task: 4 minutes 3) Answer: a-e Title: Multiple Choice Question 3 Difficulty: Medium Learning Objective 1: 12.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.2 The correct answer is All of these.

Solution: All of the answers can be considered a constructive dividend. A constructive dividend is a benefit paid to shareholders in a form other than cash, property or stock. Constructive dividend rules also apply to family members of shareholders and the dividend is taxed to the shareholder.

Time On Task: 3 minutes 4) Answer: a Title: Multiple Choice Question 4 Difficulty: Easy Learning Objective 1: 12.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.2 Solution: The correct answer is $0.

Proportionate common stock dividends are not taxable.

Time on Task: 1 minute 5) Answer: a Title: Multiple Choice Question 5 Difficulty: Medium Learning Objective 1: 12.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.2 Solution: The correct answer is Dividend income of $60,000 and capital gain of $15,000.

Dividend income, to the extent of earnings and profits, then reduces the basis ($100,000) to zero, and the remainder is capital gain.

Time On Task: 4 minutes

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6) Answer: b and d Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.3 Solution: The correct answers are Corporate stock and computer equipment purchased 3 years ago for personal use.

Answers An airplane used in a business purchased 13 months ago, machinery used in a trade or business and owned for 9 months, and cabinets held for resale to consumers are not capital assets. An airplane used in a business purchased 13 months ago and machinery used in a trade or business and owned for 9 months are used in a trade or business. Cabinets held for resale to consumers is inventory and therefore an ordinary asset. Corporate stock is an investment and is always a capital asset. The computer is personal use property which is a capital asset.

Time On Task: 3 minutes 7) Answer: b Title: Multiple Choice Question 7 Difficulty: Easy Learning Objective 1: 12.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.3 Solution: The correct answer is 15%.

The capital gains rate is 15% for individuals in the 22% regular tax bracket.

Time on Task: 2 minutes 8) Answer: a Title: Multiple Choice Question 8 Difficulty: Easy Learning Objective 1: 12.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 12.3 Solution: The correct answer is III. Personal use lawnmower

8

All personal use assets are capital. I is Section 1231, II is inventory/ordinary, and IV is ordinary.

Time On Task: 2 minutes 9) Answer: d Title: Multiple Choice Question 9 Difficulty: Hard Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: The correct answer is Gain from coins and realty.

Capital losses first offset capital gains at the highest rates: coins (28%) and depreciation (25%).

Time On Task: 5 minutes 10) Answer: c Title: Multiple Choice Question 10 Difficulty: Easy Learning Objective 1: 12.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.4 Solution: The correct answer is $1,900.

The 3.8% tax applies to the lower of: ▪ net investment income, $67,000 or ▪ the excess of modified AGI over the thresholds $50,000 ($250,000 − $200,000) Therefore, the net investment income tax equals $1,900 ($50,000  3.8%) Time On Task: 4 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.1

9

Solution: Jerome must report the interest income from a savings account of $385 and the interest income from the Coca-Cola bond of $1,300 for a total taxable interest income of $1,685. The Guam bond interest income is municipal interest income and excludable.

Time On Task: 3 minutes 2) Title: Brief Exercise 2 Difficulty: Easy Learning Objective 1: 12.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.2 Solution: Doud must report dividend income of $3,210 from all dividends received except the stock dividend. Stock dividends are typically excludable from gross (taxable) income.

Time On Task: 3 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: Christian has a net STCL of $1,500 and a net LTCL of $1,250. Christian may reduce his AGI by capital losses of up to $3,000. His new AGI is $95,650 ($98,400 − $2,750).

Time On Task: 4 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 12.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.4 Solution: The 3.8% tax applies to the lesser of (a) net investment income, or (b) the excess of modified AGI over the AGI thresholds. Wages are classified as business income, whereas annuity income, capital gains, and rental income are investment income.

The lower of:

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Net investment income = $39,500 ($10,000 + $5,500 + $24,000), or $197,500 modified AGI − $200,000 = $0, is $0. So, the net investment income tax is $0.

Time On Task: 5 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.1 Solution: Samuel will receive $2,500 from the corporate bonds and $750 from the municipal bonds.

Samuel only has to report and pay tax on the $2,500 of interest received on the corporate bonds.

The interest on municipal bonds is tax-exempt for federal income tax purposes.

Time On Task: 4 minutes 2) Title: Application Problem 2 Difficulty: Easy Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.1 Solution: Jamie must report all of the interest received in Year 9 except for the interest income earned on the Cook County bond of $1,000 and the U.S. Virgin Islands bond of $500. The Cook County bond and U.S. Virgin Islands bond are municipal bonds, and the interest is tax-exempt. Jamie’s total taxable interest income is $1,525.

Time On Task: 5 minutes 3) Title: Application Problem 3 Difficulty: Hard Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.1 Solution:

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a. The $20,000 of funds from the principal will never be taxed because this is a recovery of the taxpayer’s initial investment. Because only $25,000 was used on qualified higher education, the amount of interest that can be excluded from income is $5,769 ($6,000 × $25,000/$26,000). The remaining $231 ($6,000 − $5,769) of interest income is included in gross income. b. Because Maricel’s AGI exceeds the phaseout threshold for a single taxpayer, a portion of the excluded income will be taxable.

Percentage reduction in excluded interest = $109,950 − $96,800 $15,000

Modified AGI − $96,800 (Single) $15,000

= 88% (rounded)

The reduction is 88% × $5,769 = $5,077. Thus, of the $6,000 of interest received, a total of $692 ($5,769 − $5,077) can be excluded from gross income. The remaining $5,308 ($6,000 − $692) of interest income is included in gross income.

Time On Task: 8 minutes 4) Title: Application Problem 4 Difficulty: Hard Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.1 Solution: a. Derrick will receive $1,875 of interest every six months ($75,000  5%  6 months/12 months) that must be included in gross income. Over the next three years, Derrick will recognize total interest income of $11,250 ($3,750  3 years) if he does not elect to amortize the premium. When Derrick redeems the bond, he will have a long-term capital loss of $5,000 ($75,000 amount realized − $80,000 adjusted basis). b. If Derrick elects to amortize the bond premium, the amortization will reduce the interest income each year that must be included in gross income. During the three years, total interest income will be $6,250 ($11,250 cash received less $5,000 amortization).

The amortization will also reduce the basis of the bond to $75,000 ($80,000 cost − $5,000 amortization) so when Derrick redeems the bond there will be no capital gain or loss.

Time On Task: 8 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application 12

Section Reference 1: 12.1 Solution: The $2,400 difference in the price of the bond and its stated redemption value is a bond discount that must be amortized over the three years. The amortization of $800 ($2,400 discount/3 years) each year will be taxed as interest income and will increase the basis of the bond. When the bond is redeemed, the basis of the bond will be $12,400 ($10,000 cost + $2,400 amortization) and no gain or loss will be recognized on the redemption.

Time On Task: 5 minutes 6) Title: Application Problem 6 Difficulty: Hard Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.1 Solution: a. This is a below-market loan because Madison does not charge Mark a rate that is at least equal to the applicable federal rate. Madison must recognize interest income of $5,678 as follows: Imputed interest calculation: January 1–June 30 at 3.5% ($150,000  0.035  ½ year)

$2,625

July 1–December 31 at 4.0% [($150,000 + 2,625)  0.04  ½ year] Total imputed interest

3,053 $5,678

b. Madison will receive interest income of $3,015 from Mark. Madison must recognize total interest income of $5,678, so the imputed interest portion is $2,663 ($5,678 − $3,015).

January 1–June 30 at 2.0% ($150,000  0.02  ½ year)

$1,500

July 1–December 31 at 2.0% [($150,000 + 1,500)  0.02  ½ year] Total interest charged Time On Task: 10 minutes 7) Title: Application Problem 7 Difficulty: Hard

13

1,515 $3,015

Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.1 Solution: a. The imputed interest income would be calculated as follows: January 1–June 30 at 5.0% ($10,000  0.05  ½ year) $250 July 1–December 31 at 5.0% [(10,000 + 250)  0.05  ½ year] Total imputed interest

256 $506

A gift loan is a loan between individuals which is $10,000 or less and not used to purchase investment assets. There is no taxable imputed interest income on the loan.

Charles would not report any interest income on his tax return. b. Cristina used the loan to invest in income-producing property, ABC stock. The imputed interest income is $506 and Cristina’s net investment income is $400. Typically, Charles would have to report the lesser of the imputed interest income or the borrower’s net investment income. However, because the loan does not exceed $100,000 and the borrower’s net investment income for the year is less than $1,000, no interest is imputed or reported on Charles’s tax return. c. Cristina used the loan to invest in income-producing property, ABC stock. The imputed interest income is $506 and Cristina’s net investment income is $1,200. Charles would have to report the lesser of the imputed interest income ($506) or the borrower’s net investment income ($1,200). Therefore, Charles must report $506.

Time On Task: 10 minutes 8) Title: Application Problem 8 Difficulty: Hard Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.1 Solution: The interest accrued on this loan is $3,555 [($88,000 × 4% × 1/2) + ($89,760 × 4% × 1/2)].

Sabine recognizes $3,555 of interest income. In addition, Sabine can deduct $3,555 of compensation expense (plus related payroll expenses). Because Saquon is an employee, he is deemed to have received $3,555 of compensation income (subject to payroll taxes). The deductibility of this interest for Saquon is governed by the specific rules related to interest deductions, specifically based on the purpose for which Saquon borrowed the money.

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Time On Task: 5 minutes 9) Title: Application Problem 9 Difficulty: Medium Learning Objective 1: 12.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.2 Solution: All $2,300 of dividend income is taxed, but $1,800 is taxed at the 15% long-term capital gains rate. The remaining ordinary dividend would be taxed at their marginal rate of 22%. Total tax liability equals $380 [($1,800  15%) + ($500  22%)].

Time On Task: 4 minutes 10) Title: Application Problem 10 Difficulty: Medium Learning Objective 1: 12.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.2 Solution: The cash dividend will be taxable to Dicky to the extent of earnings and profits and will reduce Dicky’s basis in his stock to zero.

Step 1. The fair market value of the distribution is $7,000.

Step 2. This is treated as dividend income to the extent of the corporation’s earnings and profits, which is $3,800. It is a qualified dividend because the 61-day holding period requirement is met.

$7,000

Step 3. The remaining $3,200 of the distribution reduces the basis of the stock, but not below zero. Dicky’s basis is $2,800 and it is reduced to zero.

( 2,800)

Step 4. The remainder of the distribution, $400, is treated as a short-term capital gain because the stock has been owned for less than one year.

Time On Task: 8 minutes 11) Title: Application Problem 11 Difficulty: Medium

15

( 3,800) $3,200

$ 400

Learning Objective 1: 12.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.2 Solution: a. No, because the stock distribution is pro rata to the common shareholders, it is not a taxable event. b. Bane’s original stock basis was $4,000 for 400 shares. It is now divided among 800 shares providing Bane with a per share basis of $5 ($4,000/800 shares). Bruce’s original stock basis was $6,000 for 600 shares. It is now divided among 1,200 shares providing Bruce with a per share basis of $5 ($6,000/1,200 shares).

Time On Task: 6 minutes 12) Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 12.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.2 Solution: a. No, because the stock split is pro rata to the shareholders, it is not a taxable event. b. Hank’s original stock basis was $4,400 for 1,000 shares, or $4.40 per share. A 400% stock dividend provides Hank with four additional shares for every share held before the dividend. Total basis of the original shares is reallocated amongst all the shares owned after the dividend. So, $4,400/5,000 shares = $0.88 per share.

Time On Task: 6 minutes 13) Title: Application Problem 13 Difficulty: Hard Learning Objective 1: 12.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.2 Solution: $8,000 Preferred = $15,000 ×

$8,000 + $20,000

Common = $15,000 ×

$20,000 $8,000 + $20,000

= $4,286; basis is $42.86 per share ($4,286/100) = $10,714; basis is $10.71 per share ($10,714/1000)

Time On Task: 5 minutes

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14) Title: Application Problem 14 Difficulty: Medium Learning Objective 1: 12.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.2 Solution: Because the average salary for cashier work in their area is $42,000, the excess compensation of $83,000 ($125,000 − $42,000) would be considered a constructive dividend to Jamie.

Amounts paid to someone who is related to a shareholder that are in excess of the value of services the family member rendered constitute a constructive dividend to the shareholder.

Time On Task: 4 minutes 15) Title: Application Problem 15 Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: Purchase Sale Date Date 03/15/Year 7 08/14/Year 10 04/05/Year 8 10/31/Year 10 06/08/Year 9 02/14/Year 10 09/15/Year 10 12/28/Year 10

Cost $5,000 $6,500 $4,500 $9,900

Sales Proceeds $7,600 $3,000 $4,800 $7,000

Gain/loss $2,600 ($3,500) $ 300 ($2,900)

Holding Period LT LT ST ST

Charlie has a net LTCL of $900 ($2,600 LTCG − $3,500 LTCL) and a net STCL of $2,600 ($300 STCG − $2,900 LTCG) for a total capital loss of $3,500. Charlie may use up to $3,000 of net capital losses against ordinary income. Charlie’s new AGI equals $122,000. The remaining $500 of long-term capital losses can be carried forward to future tax years to offset future capital gains and ordinary income (limited to $3,000 per year).

Time On Task: 10 minutes 16) Title: Application Problem 16 Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting

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Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: Sandy has a net capital loss of $8,000 of which $3,000 can be used in the current year to offset ordinary income. The $3,000 capital loss limit is made up of short-term losses first and then long-term losses. The losses are not netted together and retain their character Therefore, the remaining $5,000 of net capital loss is carried forward indefinitely as $2,000 short-term and $3,000 long-term.

Time On Task: 5 minutes 17) Title: Application Problem 17 Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: Purchase Sale Date Date 02/14/Year 24 07/14/Year 24 04/05/Year 24 12/31/Year 24 05/05/Year 22 03/09/Year 24

Cost $2,000 $5,400 $3,300

Sales Proceeds $4,500 $5,000 $2,500

Gain/loss $2,500 ($ 400) ($ 800)

Holding Period ST ST LT

Kareem and Karen have a net STCG of $1,300 ($2,500 − $400 − $800) increasing their taxable income to $151,300. Net STCGs are taxed at the taxpayer’s ordinary rate. Using the married filing joint tax rate table for 2024, Kareem and Karen’s tax liability is $23,392 [($151,300 − $94,300)  22% + $10,852].

Time On Task: 10 minutes 18) Title: Application Problem 18 Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: Lixen and Akira’s long-term capital gain is taxed at the 15% long-term capital gains rate resulting in tax of $2,250 ($15,000  15%). The remaining taxable income of $235,300 ($250,300 − $15,000) is taxed at their ordinary tax rate using the married filing joint tables for 2024 which equals $42,557 (($235,300 − $201,050) × 24%) + $34,337). Lixen and Akira’s total tax liability is $44,807 ($2,250 + $42,557).

Time On Task: 6 minutes

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19) Title: Application Problem 19 Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: a. Shania’s adjusted basis in the apartment building is $25,000 due to the building being depreciated.

Step 1. Calculate total gain.

Amount realized $225,000 Less: Adjusted basis ( 25,000) Total gain $200,000 Step 2. Calculate tax on unrecaptured Section 1250 gain portion.

Section 1250 gain portion Taxed at lesser of: 1) $150,000  25% 2) $150,000  32%

$150,000 $ 37,500, or $ 48,000 (32% is the marginal rate on $225,000)

Step 3. Calculate the capital gains tax rate on the remaining $50,000 gain.

Shania’s 15% long-term capital gains rate applies for a single person with taxable income of $44,626 to $492,300. Shania’s taxable income after including the $200,000 gain is $425,000, so all the remaining $50,000 gain is taxed at 15%. $50,000  15% = $7,500 Step 4. Calculate total tax: Step 2 tax Step 3 tax Total tax

$37,500 7,500 $45,000

b. Shania’s adjusted basis in the apartment building is $25,000 due to the building being depreciated.

Step 1. Calculate total gain: Amount realized

$225,000

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Less: Adjusted basis ( 25,000) Total gain $200,000 Step 2. Calculate tax on unrecaptured Section 1250 gain portion.

Section 1250 gain portion Taxed at lesser of: 1) $150,000  25% 2) $150,000  35%

$150,000 $ 37,500, or $ 52,500 (35% is the marginal rate on $300,000)

Step 3. Calculate the capital gains tax rate on the remaining $50,000 gain.

Shania’s taxable income after including the $200,000 gain is $500,000, so a portion of the remaining $50,000 gain falls within the 15% capital gains rate and a portion falls within the 20% capital gains rate (15% rate applies for taxable income of $44,626 to $492,300; 20% rate begins at taxable income of $492,301). $500,000 – $492,301 = $7,699  20% = $50,000 − $7,699 = $42,301  15% = Total

$1,540 (rounded) 6,345 (rounded) $7,885

Step 4. Calculate total tax.

Step 2 tax Step 3 tax Total tax

$37,500 7,885 $45,385

c. Shania’s adjusted basis in the apartment building is $25,000 due to the building being depreciated.

Step 1. Calculate total gain.

Amount realized $225,000 Less: Adjusted basis ( 25,000) Total gain $200,000 Step 2. Calculate tax on unrecaptured Section 1250 gain portion.

Section 1250 gain portion Taxed at lesser of: 1) $150,000  25% 2) $150,000  35%

$150,000 $ 37,500, or $ 52,500 (35% is the marginal rate on $400,000)

Step 3. Calculate the capital gains tax rate on the remaining $50,000 gain.

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Shania’s taxable income after including the $200,000 gain is $600,000, so all the remaining $50,000 gain falls within the 20% capital gains rate (20% rate begins at taxable income of $492,301). $50,000  20% = $10,000 Step 4. Calculate total tax.

Step 2 tax $37,500 Step 3 tax 10,000 Total tax $47,500 Time On Task: 18 minutes 20) Title: Application Problem Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: The sale of the stamp collection (collectible) is taxed at a maximum rate of 28%, the sale of the securities (long-term capital asset) is taxed at a maximum rate of 15%, and the sale of the apartment building (realty) is taxed at a maximum rate of 25% because the gain is due to unrecaptured straight-line depreciation.

Time On Task: 4 minutes 21) Title: Application Problem 21 Difficulty: Hard Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: The total long-term capital gain is $16,500. Capital losses offset capital gains in the order of the gains taxed at the highest rate. The capital gains are taxed at the following rates.

• • •

Stamps are a collectible Apartment building due to unrecaptured straight-line depreciation Stock

28% 25% 15%

The $13,000 short-term capital loss first offsets the $6,000 gain on the stamp collection, and then offsets $7,000 of the gain attributable to depreciation. The remaining net capital gain of $3,500

21

comprises a $200 gain taxed at 25% (the apartment building) and a $3,300 gain (the stock) taxed at a maximum rate of 15%.

Time On Task: 6 minutes 22) Title: Application Problem 22 Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: a. Buddy must first offset the casualty gain ($10,000) against the non-federally declared casualty loss ($15,000) resulting in a net casualty loss of $5,000. This loss is personal in nature and does not relate to a federally declared disaster, so the loss is not deductible.

The $18,000 casualty loss does relate to a federal disaster area, so it is deductible. Buddy will be able to deduct a net casualty loss of $8,000 [$18,000 – (10%  $100,000 AGI)] as an itemized deduction. b. Buddy must first offset the casualty gain ($10,000) against the non-Federally declared casualty loss ($5,000) resulting in a net casualty gain of $5,000. Buddy can use this gain of $5,000 to offset the personal casualty loss from the tornado of $18,000, resulting in a net personal casualty loss of $13,000. Buddy will be able to deduct a net casualty loss of $3,000 [$13,000 – (10%  $100,000 AGI)] as an itemized deduction.

Time On Task: 8 minutes 23) Title: Application Problem 23 Difficulty: Hard Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: a. Cynthia has a long-term capital gain of $22,000 ($57,000 amount realized − $35,000 adjusted basis) which will be taxed at 15%. Cynthia did not hold the qualified small business stock for at least five years to qualify for the 100% gain exclusion. b. Cynthia has a realized long-term capital gain of $22,000, all of which will be excluded from her income. Cynthia held the qualified small business stock for at least five years to qualify for the 100% gain exclusion. c. Cynthia has a realized long-term capital gain of $22,000 which will be excluded 50% from her income. She purchased the stock on August 5, 2000, qualifying her for the 50%

22

gain exclusion. The remaining $11,000 of gain will be taxed at 28%, the lower of 28% or her ordinary tax rate of 32%.

Time On Task: 6 minutes 24) Title: Application Problem 24 Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: Melanie and Marcus will have a capital loss of $140,000. Of this amount, $100,000 is treated as an ordinary loss and the remaining $40,000 is treated as a long-term capital loss. If there are no other capital transactions this year, they may deduct $3,000 of the $40,000 loss. Thus, the total deductible loss for the current year is $103,000, and there is a capital loss carryforward of $37,000.

Time On Task: 5 minutes 25) Title: Application Problem 25 Difficulty: Hard Learning Objective 1: 12.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.3 Solution: a. Darius has a short-term capital gain of $1,500 ($6,500 – $5,000). The asset is a capital asset in Darius’s hands, and he held the option for only 10 months making it short-term. b. Darius’s basis in the land acquired is $105,000 ($5,000 + $100,000). The option price is added to the purchase price of the land.

Time On Task: 5 minutes 26) Title: Application Problem 26 Difficulty: Medium Learning Objective 1: 12.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 12.4 Solution:

23

The 3.8% tax applies to the lesser of (a) net investment income, or (b) the excess of modified AGI over the AGI thresholds. Wages are classified as business income, whereas interest, dividends, and capital gains are investment income.

The lower of: 1. Net investment income = $62,800 ($1,200 + $3,600 + $58,000), or 2. $201,300 modified AGI – $200,000 = $1,300, is $1,300. So, the net investment income tax is $49 ($1,300  3.8%). Modified AGI is $138,500 + $1,200 + $3,600 + $58,000 = $201,300.

Time On Task: 8 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Difficult Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 12.1 Solution: DeKalb County bonds are municipal bonds and Edward will not pay any income tax on their earnings. Edward will pay tax on the interest generated on the DeKalb Manufacturing Company bonds.

DeKalb County Bond DeKalb Manufacturing Co. Investment $400,000 $400,000 Interest rate 3% 4.25% Interest earned $ 12,000 $ 17,000 Less: Tax paid ( 0) ( 5,440) (32%  $17,000) Net cash flow $ 12,000 $ 11,560 Even though the interest rate is greater for the corporate bonds than the county bonds, the tax that has to be paid on the corporate bond’s interest income offsets the higher interest rate. The better net cash flow is $12,000 with the DeKalb County Bonds.

Time On Task: 10 minutes 2) Title: Tax Planning Problem 2 Difficulty: Difficult Learning Objective 1: 12.1 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 12.1

24

Solution:

Kerry Michael Carly Ed Kane

Imputed interest $ 7,500 (150,000  0.05) $ 2,500 (50,000  0.05) $ 500 (10,000  0.05) $ 400 (8,000  0.05) $ 750 (15,000  0.05)

Reported Interest: Lesser of imputed interest or borrower’s net investment income $7,500 $1,200 $ 0 $ 0 $ 0

Lita must report interest income on her tax return as follows: Kerry—The loan outstanding is greater than $100,000 and imputed interest ($7,500) must be reported but not to exceed the borrower’s net investment income (12,500).

Michael—The loan outstanding is greater than $10,000 and imputed interest must be reported if the borrower’s net investment income is more than $1,000. The reported interest income ($2,500) cannot exceed the borrower’s net investment income ($1,200), so $1,200 must be reported as interest income.

Carly—The loan outstanding is $10,000 or less, so no imputed interest income needs to be reported if the loan was not used to purchase income-producing property.

Ed—The loan outstanding is $10,000 or less. However, the loan was used to purchase incomeproducing property generating net investment income to Ed of $500. Because the net investment income is not more than $1,000, no imputed interest income is reported.

Kane—The loan outstanding is greater than $10,000 and imputed interest must be reported if the borrower’s net investment income is more than $1,000. The reported interest income will not exceed the borrower’s net investment income, which is $0.

Time on Task: 12 minutes Communication Problem 1) Title: Communication Problem Difficulty: Medium Learning Objective 1: 12.3 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 12.3 Solution: Hello Delilah,

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Thank you for allowing me to assist you in preparing your 2024 tax return. I have reviewed the information you have provided and will explain how each of these transactions affect your 2024 income tax liability.

Asset Gold coins Tan Corporation Walgreens Co.

Purchase date 06/04/2022 04/10/2019 08/05/2020

Sale date 07/24/2024 12/15/2024 03/19/2024

Cost $3,000 $2,750 $6,300

Sales proceeds $4,500 $5,000 $10,000

Gain/ Loss $1,500 $2,250 $3,700

As you can see in the above chart, all your assets were held long-term and sold at a gain. I will walk you through each sale and discuss its result.

•

• •

You sold the gold coins, a collectible capital asset, and recognized a long-term capital gain. Collectibles are taxed at the lower of 28% or your marginal tax rate for ordinary income based on your taxable income of $185,000, or 32%. Therefore, your tax rate for the collectible gain is 28%.

Tan Corporation qualifies as small business stock and is eligible for 100% exclusion under IRC §1202. Your gain of $2,250 is excluded from taxable income.

The Walgreens stock was a capital asset, held long-term and sold at a gain of $3,700 which is eligible for a preferential tax rate of 15%. Long-term capital assets sold at a gain receive preferential rate treatment and are taxed using the 2024 tax brackets for long-term capital gains.

Your final tax liability is calculated as follows: Asset Gold coins Tan–Section 1202 stock Walgreens Co. Tax on $185,000 using single rate table

Tax rate 28% 0% 15%

Tax liability $ 420 $ 0 $ 555 $ 37,443 ($185,000 −$100,525)  24% plus $17,169 24%



Total tax liability

$ 38,418

Please let me know if I can be of further assistance or if you need further clarification.

Sincerely, Carnes & Youngberg, CPAs Time On Task: 15 minutes Ethics Problem 1) Title: Ethics Problem Difficulty: Medium

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Learning Objective 1: 12.3 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 12.3 Solution: In Statement on Standards for Tax Services No. 2.4.2, Use of Estimates, a member may use the taxpayer’s estimates in the preparation of a tax return "if it is not practical to obtain exact data and if the member verifies that the estimates are reasonable based on the facts and circumstances known to the member. Estimates should be presented in a manner that does not imply greater accuracy than exists."

Stacy has been honest in the past, but the tax preparer must also exercise due diligence when preparing the tax return. Circular 230 §10.22(a)(2) requires due diligence as to accuracy when relying on the representations of clients. If the fair market value can be determined with relative ease by obtaining the data as of the date of death from another reliable source such as The Wall Street Journal or other sources, then the tax preparer has a responsibility to do so.

The CPA should make reasonable efforts to verify Stacy’s numbers for accuracy before signing the tax return.

Tax Compliance and Reporting Problem 1) Difficulty: Medium Learning Objective 1: 12.1-4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 12.1-4 Solution: This problem is for 2024. The answer is reported on 2023 tax forms since that was the most recent return available at the time of publication.

Tax liability: Taxable income Less: Qualified dividends Less: LTCG Distributions Taxable income less items tax at preferred rates Tax Liability

$465,565 (see Form 1040) (12,550) ( 3,850) $449,165

$ 99,106 (Tax liability on $449,165) [($449,165 − $383,900)  32% + $78,221] Preferential tax 2,460 [($12,550 + $3,850)  15%] Net investment tax 781 (See Form 8960) Total tax liability $102,347 Time On Task: 20 minutes

27

[[COMP: See high-res PDF file submitted: "Carnes_I2025_Ch12_SM_TaxComplianceProblem_Form 1040 2023 Chase.pdf"]]

28

[[COMP: See high-res PDF file submitted: "Carnes_I2025_Ch12_SM_TaxComplianceProblem_Form 1040 Sch B 2023 Chase.pdf"] 29

[[COMP: See high-res PDF file submitted: "Carnes_I2025_Ch12_SM_TaxComplianceProblem_Form 8960 2023 Chase.pdf."]]

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Research Problem 1) 31

Title: Research Problem Difficulty: Medium Learning Objective 1: 12.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 12.2 Solution: Gia must include in income the fair market value of the rental use of $1,080 ($360  3 nights), medical expenses paid of $4,500, and the private schooling paid of $5,000. All of these are considered constructive dividends to Gia whether they were paid directly to Gia or not.

Constructive dividends are benefits paid to shareholders in a form other than cash, property, or stock. The law treats these benefits as ordinary income and the corporation receives no deduction for the benefits provided. The constructive dividend rules also apply to family members of shareholders. The tax law defines family members as the shareholder’s spouse, children, grandchildren, and parents. The dividend is taxed to the shareholder even if the family member receives all the economic benefit (Treas. Reg. §1.301-1).

Some examples of constructive dividends are: • Shareholder use of corporate-owned property • Bargain sale of corporate property to a shareholder • Bargain rental of corporate property • Payments for the benefit of a shareholder Time On Task: 15 minutes Excel Problem 1) Title: Excel Problem Difficulty: Hard Learning Objective 1: 12.3 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 12.3 Solution: Using Excel, Alphabet Inc. produces an after-tax income of $384,627. Coca-Cola produces an after-tax income of $393,127. The couple can only sell the Alphabet stock to avoid the top capital gains bracket. By selling Coca-Cola, a portion of the capital gain will be taxed at 20% because of the overall taxable income level.

Time On Task: 25 minutes [[COMP: See Excel file submitted for this Solution: "Carnes_I2025_Ch12_SM_Excel Problem Solution 2024.xlsx"]]

32

Input Area Stock Name

Alphabet

Ordinary Income Net LTCG Taxable Income

475,000 20,000 495,000

Calculations - 2024 Regular Income Tax 10% 12% 22% 24% 32% 35% 37%

Capital Gains Tax 20% 15% 0%

Taxable Income 23,200 94,300 201,050 383,900 487,450 731,200

Regular Tax 2,320 8,532 23,485 43,884 29,152 107,373

Taxable Income 583,750 94,050 -

LTCG Tax 3,000 3,000 110,373 384,627

Total Tax Net After Tax Income

Formulas

33

Bracket 23,199 71,100 106,750 182,850 103,550 243,750 -

Balance 475,000 451,801 380,701 273,951 91,101 -

LTCG 20,000 -

Balance 20,000 20,000 -

Input Area Stock Name

Alphabet

Ordinary Income Net LTCG Taxable Income

475000 20000 =+B7+B6

Calculations - 2024 Regular Income Tax 0.1 0.12 0.22 0.24 0.32 0.35 0.37

Capital Gains Tax 0.2 0.15 0

Regular Tax Bracket =ROUND(+A13*MIN(D13,E13),0) =+B14-B13-1 =ROUND(+A14*MIN(D14,E14),0) =+B15-B14 =ROUND(+A15*MIN(D15,E15),0) =+B16-B15 =ROUND(+A16*MIN(D16,E16),0) =+B17-B16 =ROUND(+A17*MIN(D17,E17),0) =+B18-B17 =ROUND(+A18*MIN(D18,E18),0) =+B19-B18 =ROUND(+A19*MIN(D19,E19),0) =MAX(0,+E18-D18) =SUM(C13:C19)

Taxable Income

LTCG Tax =ROUND(+D24*A24,0) =ROUND(+D25*A25,0) =ROUND(+D26*A26,0) =SUM(C24:C26) =+C27+C20 =+B8-C28

0 23200 94300 201050 383900 487450 731200

583750 94050 0 Total Tax

Net After Tax Income

Taxable Income

34

Balance =+B8-B7 =IF(+E13-D13<0,0,+E13-D13) =IF(+E14-D14<0,0,+E14-D14) =IF(+E15-D15<0,0,+E15-D15) =IF(+E16-D16<0,0,+E16-D16) =IF(+E17-D17<0,0,+E17-D17) =IF(+E18-D18<0,0,+E18-D18)

LTCG Balance =MIN(E24,IF(B$8-B24<0,0,B$8-B24)) =+B7 =MIN(E25,IF(B$8-B25<0,0,MIN(B$8-B25,B24-B25))) =+E24-D24 =MIN(E26,IF(B$8-B26<0,0,MIN(B$8-B26,B25-B26))) =+E25-D25

Input Area Stock Name

Coca-Cola

Ordinary Income Net LTCG Taxable Income

475,000 30,000 505,000

Calculations - 2024 Regular Income Tax 10% 12% 22% 24% 32% 35% 37%

Capital Gains Tax 20% 15% 0%

Taxable Income 23,200 94,300 201,050 383,900 487,450 731,200

Regular Tax 2,320 8,532 23,485 43,884 29,152 107,373

Taxable Income 583,750 94,050 -

LTCG Tax 4,500 4,500 111,873 393,127

Total Tax Net After Tax Income

Bracket 23,199 71,100 106,750 182,850 103,550 243,750 -

Balance 475,000 451,801 380,701 273,951 91,101 -

LTCG 30,000 -

Balance 30,000 30,000 -

Formula

35

Input Area Stock Name

Coca-Cola

Ordinary Income Net LTCG Taxable Income

475000 30000 =+B7+B6

Calculations - 2024 Regular Income Tax 0.1 0.12 0.22 0.24 0.32 0.35 0.37

Capital Gains Tax 0.2 0.15 0

Regular Tax Bracket =ROUND(+A13*MIN(D13,E13),0) =+B14-B13-1 =ROUND(+A14*MIN(D14,E14),0) =+B15-B14 =ROUND(+A15*MIN(D15,E15),0) =+B16-B15 =ROUND(+A16*MIN(D16,E16),0) =+B17-B16 =ROUND(+A17*MIN(D17,E17),0) =+B18-B17 =ROUND(+A18*MIN(D18,E18),0) =+B19-B18 =ROUND(+A19*MIN(D19,E19),0) =MAX(0,+E18-D18) =SUM(C13:C19)

Taxable Income

LTCG Tax =ROUND(+D24*A24,0) =ROUND(+D25*A25,0) =ROUND(+D26*A26,0) =SUM(C24:C26) =+C27+C20 =+B8-C28

0 23200 94300 201050 383900 487450 731200

583750 94050 0 Total Tax

Net After Tax Income

Taxable Income

36

Balance =+B8-B7 =IF(+E13-D13<0,0,+E13-D13) =IF(+E14-D14<0,0,+E14-D14) =IF(+E15-D15<0,0,+E15-D15) =IF(+E16-D16<0,0,+E16-D16) =IF(+E17-D17<0,0,+E17-D17) =IF(+E18-D18<0,0,+E18-D18)

LTCG Balance =MIN(E24,IF(B$8-B24<0,0,B$8-B24)) =+B7 =MIN(E25,IF(B$8-B25<0,0,MIN(B$8-B25,B24-B25))) =+E24-D24 =MIN(E26,IF(B$8-B26<0,0,MIN(B$8-B26,B25-B26))) =+E25-D25

CPA Exam Preparation: Task-Based Simulation: Net Investment Income Tax 1) Difficulty: Medium Learning Objective 1: 12.1-4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 12.1-4

1 From the Exhibits provided, what is Jackson’s total investment income?

2 If taxable income is $125,000 (including the investment income), what tax rate is applicable for the qualified dividend income and long-term capital gain?

Assume the net investment income tax is not applicable.

3 If Jackson’s Modified AGI is $260,000 (including the investment income), what is his net investment income tax?

4 If Jackson’s taxable income is $200,000, at what rate is the sports card memorabilia taxed?

$35,600

15%

$1,353

28%

1. Calculate total investment income: Investment income includes taxable interest income, dividends, annuities, certain royalties and rents not generated from a trade or business, and net gains from the sale of investment property.

Blackhawk Corporation dividend income CubbyBlue Inc. dividend income Windy City Bank interest income Net capital gain: Blackhawk Corporation long-term capital gain CubbyBlue Inc. short-term capital gain Sports card memorabilia short-term capital gain Total capital gain Total investment income

$4,000 2,500 2,350 2,750 1,000 23,000 26,750 $35,600

The tax-exempt income from Cook County Bank is not included in net investment income.

2. Tax rate applicable for qualified dividends and long-term capital gains

37

Based on the tax brackets provided for long-term capital gains for a single filer with taxable income of $125,000, his rate is 15%. Qualified dividend income is broadly defined as dividends from taxable domestic corporations and qualified foreign corporations.

Qualified dividend income and long-term capital gains are taxed at a preferential rate for individuals. The tax rate is 0% for qualified dividends and long-term capital gains if the taxpayer is in the lower tax bracket, 20% for qualified dividends and long-term capital gains in the higher tax bracket, and 15% for all other tax brackets.

3. Calculation for net investment income tax Taxpayers may be subject to the net investment income tax if they have significant investment income. Investment income includes taxable interest income, dividends, annuities, certain royalties and rents not generated from a trade or business, passive income, and net gains from the sale of investment property.

The tax equals 3.8% of the lesser of: 1) an individual's net investment income, or 2) the excess of modified AGI over a threshold amount.

The threshold amount is $200,000 for unmarried individuals and $250,000 for married filing joint ($125,000 for married filing separately). These amounts are not indexed for inflation.

Lower of: 1. Net investment income = $35,600, or 2. $260,000 (Modified AGI) − $200,000 threshold = $60,000 is net investment income of $35,600. Therefore, the net investment income tax is $1,353 ($35,600  3.8%).

4. Sports card memorabilia tax rate Sports card memorabilia is a collectible. The tax rate for collectibles is the lower of the marginal rate for ordinary income or 28%. Based on Jackson’s taxable income of $200,000, his marginal tax rate for ordinary income is 32%, so the tax rate for the memorabilia gain is 28%.

Time On Task: 25 minutes

38

Chapter 13 – Cost Recovery of Property End of Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Easy Learning Objective 1: 13.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.1 Solution: Depreciation is an accounting method used to spread the deduction of the cost of an asset over the asset’s useful life. An asset loses value over time due to wear and tear, physical deterioration, or obsolescence and a business deduction is allowed for the cost recovery.

Time On Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Easy Learning Objective 1: 13.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.1 Solution: MACRS is an acronym for Modified Accelerated Cost Recovery System. MACRS has been in effect since 1987. MACRS uses specified recovery periods, depreciation methods, and conventions to determine the depreciation deduction. Zero salvage value is assumed.

Time On Task: 2 minutes 3) Title: Discussion Question 3 Difficulty: Easy Learning Objective 1: 13.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.1 Solution: MACRS applies to both depreciable realty (buildings, improvements, and other structures permanently attached to the land) and personalty (any tangible asset not part of a building or other permanent structure). The asset must be used in a trade or business, or in an incomeproducing activity. Every asset is assigned one of ten recovery periods.

Time On Task: 2 minutes 4) Title: Discussion Question 4 Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.1 Solutions: The three conventions that are used for MACRS are the half-year, the mid-quarter, and the midmonth.

The half-year convention applies to personalty. Six months of depreciation is allowed in the first year, regardless of when the asset was actually purchased and placed in service.

The mid-quarter convention is an exception to the half-year convention. If more than 40% of the depreciable personalty is purchased and placed into service in the last three months of the year, the business must use the mid-quarter convention for all personalty purchased and placed in service during the year. Under the mid-quarter convention, it is assumed that personalty is placed in service at the midpoint of the quarter (one and one-half months).

The mid-month convention applies to depreciable realty. Realty placed in service during any month is deemed placed in service at the midpoint of the month. All of these conventions apply in the year, month, or quarter the asset is sold in the same manner as when purchased.

Time on Task: 3 minutes 5) Title: Discussion Question 5 Difficulty: Easy Learning Objective 1: 13.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.1 Solution: The most common recovery periods are 27.5 years for residential rental realty and 39 years for nonresidential real property such as warehouses, office buildings, and factories.

Time On Task: 2 minutes 6) Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting

Standard 3: Bloom's || Knowledge Section Reference 1: 13.1 Solution: If a company placed a building into service on December 25, the company would receive onehalf month of depreciation. Realty placed in service during any month is treated as placed in service at the midpoint of the month regardless of when during the month (period) the asset was placed in service.

Time On Task: 2 minutes 7) Title: Discussion Question 7 Difficulty: Medium Learning Objective 1: 13.1,2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.1,2 Solution: A qualified improvement property (QIP) is an improvement to the interior of nonresidential real property after the realty was first placed in service. Leasehold improvements made by the lessor usually meet the definition of QIP, are depreciated using straight-line depreciation over 15 years, and are eligible for Section 179 and bonus depreciation. Expenses incurred to enlarge the building, install elevators and escalators, and improvements that are structural do not qualify and must be capitalized as additions to the building.

Time On Task: 4 minutes 8) Title: Discussion Question 8 Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.1 Solution: In the year of disposition for personalty using the half-year convention, six months of depreciation are allowed as a deduction. The actual month of disposal is irrelevant.

Time On Task: 3 minutes 9) Title: Discussion Question 9 Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge

Section Reference 1: 13.2 Solution: Section 179 is an expensing election that allows a business to expense purchased assets instead of capitalizing them. The dollar limit for expensing a Section 179 asset is $1,220,000 for 2024.

This maximum deduction begins to phase out if the business purchases more than $3,050,000 in qualifying property. Section 179 is to allow businesses to write off a portion of their qualifying asset purchases immediately, to receive a tax deduction and encourage businesses to continue to expand and grow their businesses. Smaller businesses avoid the burden of maintaining depreciation schedules.

Time On Task: 3 minutes 10) Title: Discussion Question 10 Difficulty: Easy Learning Objective 1: 13.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.2 Solution: Tangible depreciable property used in a trade or business, but not income-producing property such as rental property, qualifies for Section 179 expensing. It applies to both new and used property. Qualified property includes energy-efficiency improvements to lighting, heating, cooling, ventilation, and hot water systems of nonresidential buildings; roofs, heating and air conditioning, fire protection, and security systems added to nonresidential real property if done after the taxpayer first places it in service; off the shelf computer software; and qualified improvement property (QIP).

Time On Task: 2 minutes 11) Title: Discussion Question 11 Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.2 Solution: Yes, Section 179 and bonus depreciation can be taken in the same year. Section 179 is an expensing election that allows a business to expense assets purchased instead of capitalizing them. The dollar limit for expensing Section 179 assets is $1,220,000 for 2024. Bonus depreciation for acquisitions between September 28, 2017 and December 31, 2022 is 100% of qualifying purchases. For assets purchased in 2024, the bonus depreciation percentage is reduced to 60%. Assets eligible for bonus depreciation include new and used tangible assets with a recovery period of 20 years or less, computer software, QIP, and certain property used in film,

television, or live theater production. Unlike Section 179, bonus depreciation applies unless the taxpayer elects otherwise.

Time On Task: 3 minutes 12) Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.2 Solution: The annual depreciation deduction for passenger autos may not exceed certain limits that are changed for inflation each year. A passenger automobile is a four-wheeled vehicle with a gross weight of 6,000 pounds or less. The business will calculate the MACRS depreciation deduction and the limit available each year and deduct the lesser of the two. Both calculations must consider the business use percentage.

Time On Task: 2 minutes 13) Title: Discussion Question 13 Difficulty: Hard Learning Objective 1: 13.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.2 Solution: The Alternate Depreciation System (ADS) is one of two systems for calculating depreciation.

MACRS is the other system. ADS generally increases the number of years over which property is depreciated, thus decreasing the annual deduction. Most businesses will use MACRS because it allows for a faster write-off of the asset. ADS must be employed for listed property that is used 50% or less for business purposes. Some businesses elect to use ADS instead of MACRS. Listed property includes passenger automobiles weighing 6,000 pounds or less, other property used for transportation, like a motorcycle or boat, or property generally used for entertainment, recreation, or amusement, including digital cameras and video recording equipment. For personalty, the alternative depreciation system (ADS) provides for straight-line or 150% declining balance over an extended life, compared to the general MACRS recovery periods. The most common lives for personalty under ADS are 5 years, 10 years, and 12 years. For realty, ADS provides for straightline depreciation, with a recovery period of 30 years for residential real property and 40 years for nonresidential real property.

Time On Task: 5 minutes 14) Title: Discussion Question 14

Difficulty: Easy Learning Objective 1: 13.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.3 Solution: Amortization is used to recover the costs of intangible assets. Intangible assets are assets with no physical substance but that have value. Examples of intangible assets are patents, copyright, franchises, goodwill, trademarks, and trade names. There is no salvage value, and the amortization period is usually 15 years.

Time On Task: 2 minutes 15) Title: Discussion Question 15 Difficulty: Easy Learning Objective 1: 13.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.4 Solution: Depletion is used to recover the costs of natural resources. Businesses incur costs to purchase and develop real property from which to extract natural resources (minerals, oil, gas, and other natural deposits) from the earth in their mines and wells. Cost depletion and percentage depletion are the two methods that are used to calculate the depletion deduction.

Time On Task: 2 minutes Multiple Choice Questions 1) Answer: b Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: Correct answer is $288 ($5,000  11.52%  50%).

Year 5 depreciation rate is 11.52% multiplied by 1/2 because the asset was sold in Year 5.

Time On Task: 3 minutes 2) Answer: a

Title: Multiple Choice Question 2 Difficulty: Easy Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: Correct answer is $12,840. $800,000 of the cost is depreciable, straight-line over 39 years. Using Table 4, nonresidential property, depreciation expense is $12,840 ($800,000  1.605%).

Time On Task: 3 minutes 3) Answer: c Title: Multiple Choice Question 3 Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: Correct answer is mid-quarter and mid-month.

Mid-quarter applies to equipment and computers because the 40% test is met for personalty purchased in 4th quarter. Mid-month applies to the storage building.

Time On Task: 3 minutes 4) Answer: e Title: Multiple Choice Question 4 Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: Correct answer is both the new office furniture and the used delivery van.

Bonus depreciation and Section 179 apply to used and new property. Section 179 and bonus depreciation do not apply to land or patents.

5) Answer: b Title: Multiple Choice Question 5 Difficulty: Medium

Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: Correct answer is $1,110,000.

The purchase price of $3,160,000 exceeds the threshold of $3,050,000 (2024) for qualifying purchases under Section 179 by $110,000. Therefore, the excess amount of $110,000 reduces the available Section 179 deduction to $1,110,000 ($1,220,000 − $110,000). ABC Company may expense $1,110,000 under Section 179 and must capitalize the remaining $2,050,000 and recover it through MACRS depreciation (because the facts do not indicate that ABC is using bonus depreciation).

Time On Task: 4 minutes 6) Answer: a Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: Correct answer is $8,060.

In 2024, Stanley can take the lesser of: $63,000  20% MACRS  65% business use = $8,190 $12,400 auto limit  65% business use = $8,060 Time on Task: 4 minutes 7) Answer: c Title: Multiple Choice Question 7 Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: Correct answer is $40,000.

Rachel's Section 179 expense is limited to the $40,000 of business income before Section 179.

The remaining $85,000 ($125,000 − $40,000) is carried forward to future years and will be deducted when there is enough business income.

Time On Task: 4 minutes

8) Answer: d Title: Multiple Choice Question 8 Difficulty: Easy Learning Objective 1: 13.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.3 Solution: Correct answer is all of these.

Goodwill, franchises, and patents are all examples of amortizable intangible assets.

Time On Task: 2 minutes 9) Answer: a Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 13.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.4 Solution: Correct answer is $100,000.

Cost − Accumulated Depletion/ Number of Recoverable Units  Number of Units sold $800,000/800  100 = $100,000 Time On Task: 4 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: Vickie’s total depreciation deduction is $16,900. See Appendix 13A, MACRS Table 1.

One-year-old filly (3 yr.)

Machinery (5 yr.)

Light duty truck (5 yr.)

$ 4,500  33.33% = $ 1,500 $ 35,000  20% = 7,000 $ 42,000  20% = 8,400

Total

$16,900

The half-year convention is used because all the assets were placed in service before the 4th quarter, so the mid-quarter convention does not apply. Land is not a depreciable asset and, therefore, is not included in the calculation of depreciation.

Time On Task: 5 minutes 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: Cal’s total depreciation deduction is $1,687.

Equipment #1 (7 yr.) 02/27/24 Equipment #2 (7 yr.) 10/15/24 Total

$5,500  25% (1st qtr.) = $1,375 (See MACRS Table 2a) $8,750  3.57% (4th qtr.) = 312 (See MACRS Table 2d) $1,687

Cal purchased $8,750 of the personalty in the 4th quarter, and this is more than 40% of the adventure park’s purchases for the year ($8,750/($5,500 + $8,750) = 61.40%). Therefore, the mid-quarter convention applies to all tangible personalty purchased this year.

Time On Task: 5 minutes 3) Title: Brief Exercise 3 Difficulty: Easy Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: None of Deepak’s purchases qualify for bonus depreciation. The warehouse is a building and does not qualify, land is not a depreciable asset, and the supplies are written off in the current year as an expense.

Time On Task: 3 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Analytic

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: Alisha’s depreciation deduction is $4,830. Alisha's depreciation is calculated by determining the lower of: Regular MACRS depreciation ($32,200  20%  75%) $4,830 (See MACRS Table 1) or Luxury automobile limit ($12,400  75%) $9,300 Time On Task: 4 minutes 5) Title: Brief Exercise 5 Difficulty: Medium Learning Objective 1: 13.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.3 Solution: LTT’s amortization expense is $1,120.

Purchased patent Created patent Total

$36,400/15 years  5/12 $22,200/17 year  1/12

$1,011 109 $1,120

LTT can amortize patents over 17 years, because that is the legal life of a patent. However, if the business acquires the patent as part of the acquisition of another business, it is amortized over 15 years under Section 197. In both cases, LTT can take a full month of amortization beginning with the month the patent is acquired.

Time On Task: 4 minutes 6) Title: Brief Exercise 6 Difficulty: Medium Learning Objective 1: 13.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.4 Solution: The depletion in 2023 and 2024 can be determined as follows:

2023 2024

Percentage depletion (5%  Gross Income) Taxable Income Limit (50%) $ 82,000 (5%  $1,640,000) $400,000 ($800,000  50%) $444,000 (5%  $8,880,000) $375,000 ($750,000  50%)

In 2023, the percentage depletion was $82,000, because the percentage depletion is less than the taxable income limit.

Because in 2024 the taxable income limit is lower than the computed depletion of $444,000, the deduction is limited to $375,000.

Time On Task: 4 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Easy Learning Objective 1: 13.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.1 Solution: a. Residential rental property – 27.5 years b. Computer – 5 years c. Warehouse – 39 years d. Land – Not depreciable e. Delivery truck – 5 years f. Office furniture – 7 years g. A one-year-old racehorse – 3 years Time On Task: 5 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: See MACRS Table 1.

Year Basis 1 $32,000 2 $32,000 3 $32,000 4 $32,000 5 $32,000 6 $32,000 Total MACRS depreciation

Table Percentage 20.00% 32.00% 19.20% 11.52% 11.52% 5.76%

MACRS Depreciation $ 6,400 10,240 6,144 3,686 3,686 1,844 $32,000

The asset has a 5-year recovery period, but because of the half-year convention, depreciation is taken in year 6 as well.

Time On Task: 5 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: See MACRS Table 1.

Asset

Date placed in service

Cost

Recovery Period

Depreciation

Small tools Computer Furniture

2/8/2024 5/26/2024 7/31/2024

$4,100 $1,450 $7,000

3 years 5 years 7 years

$1,367 ($4,100  33.33%) $ 290 ($1,450  20%) $1,000 ($7,000  14.29%)

Theo may use the half-year convention to depreciate his business use assets. No asset was placed in service in the 4th quarter so the mid -quarter convention does not apply.

Time On Task: 5 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution:

Asset Year Apt. building 2022 2023 2024 Total depreciation

Basis $500,000 $500,000 $500,000

Recovery Period 27.5 years

Depreciation $ 3,790 ($500,000  0.758%) 18,180 ($500,000  3.636%) 18,180 ($500,000  3.636%) $40,150

The apartment building is residential rental property (MACRS Table 3) depreciated over a 27.5year recovery period. The building was purchased and placed in service in October, so the 10th-

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month column was used to calculate depreciation. The depreciable basis of the building does not include $50,000 allocated to land.

Time On Task: 5 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: Asset Storefront Property

Year

10/2022 2023 2024 Total depreciation

Basis $500,000 $500,000 $500,000

Recovery Period 39 years

Depreciation $ 2,675 ($500,000  .535%) 12,820 ($500,000  2.564%) 12,820 ($500,000  2.564%) $28,315

The storefront property is non-residential realty (MACRS Table 4) depreciated over a 39-year recovery period. The building was purchased and placed in service in October, so the 10th-month column was used to calculate depreciation. The depreciable basis of the building does not include $50,000 allocated to land.

Time On Task: 5 minutes 6) Title: Application Problem 6 Difficulty: Hard Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: Date placed Asset in service Computer 2/24/2024 Machinery 7/29/2024 Landscaping 11/30/2024 Total depreciation

Cost $ 1,000 $10,000 $ 7,500

Recovery Period 5 years 7 years 15 years

Depreciation $ 350 ($1,000  35%, 1st qtr.)

1,071 ($10,000  10.71%, 3rd qtr.)

94 ($7,500  1.25%, 4th qtr.) $1,515

Mid-quarter convention (MACRS Tables 2a, 2c, 2d) was applied because the landscaping was purchased in the 4th quarter and its purchase price of $7,500 accounted for more than 40% of the total personalty purchased, 40.5% ($7,500/$18,500).

Time On Task: 8 minutes 7) Title: Application Problem 7 Difficulty: Hard Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: See Table 1.

Asset

Year

Equipment

2022 2023 2024 Total depreciation

Basis $32,000 $32,000 $32,000

Recovery Period 7 years

Depreciation $ 4,573 ($32,000  14.29%) 7,837 ($32,000  24.49%) 2,798 ($32,000  17.49%  1/2) $15,208

Laquinta may use the half-year convention to depreciate her equipment. No asset was placed in service in the 4th quarter so the mid-quarter convention would not apply. In the year of disposition, only one-half of the year’s depreciation is allowed.

Time On Task: 8 minutes 8) Title: Application Problem 8 Difficulty: Hard Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: See MACRS Table 3.

Asset Year Apt. building 2021 2022 2023 2024

Basis $200,000 $200,000 $200,000 $200,000

Recovery Period 27.5 years

Depreciation $ 6,364 ($200,000  3.182%) 7,272 ($200,000  3.636%) 7,272 ($200,000  3.636%) 5,151 ($200,000  3.636%  8.5/12)

Total depreciation

$26,059

The apartment building is residential rental property depreciated over a 27.5-year recovery period. The building was purchased and placed in service in February so the 2nd month column in MACRS Table 3 was used to calculate depreciation. In the year of disposition, the depreciation is pro-rated based on the number of months held, with one-half month of the month the asset was sold. The building was sold in September, so eight full months plus one-half of a month for September is allowed for depreciation. The denominator is 12 representing the 12 months in a year.

Time On Task: 8 minutes 9) Title: Application Problem 9 Difficulty: Hard Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.1 Solution: See MACRS Table 2d.

Asset Equipment

Year

10/2022 2023 2024 Total depreciation

Basis $40,000 $40,000 $40,000

Recovery Period 7 years

Depreciation $ 1,428 ($40,000  3.57%, 4th qtr.)

11,020 ($40,000  27.55%, 4th qtr.)

4,920 ($40,000  19.68%  2.5/4) $17,368

Mid-quarter convention was applied because the equipment was purchased in the 4th quarter and was the only asset placed in service. The fourth quarter table was used (MACRS Table 2d) to calculate the depreciation deduction. In the year of disposition, only the quarters held plus onehalf quarter is allowed for depreciation. The equipment was sold in September, so two full quarters plus one-half quarter is allowed for depreciation. The denominator is 4 representing the four quarters in a year.

Time On Task: 8 minutes 10) Title: Application Problem 10 Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution:

a. Jeremiah can deduct the entire $875,000 as depreciation under Section 179. b. The purchase price of $3,100,000 exceeds the threshold of $3,050,000 (2024) for qualifying purchases under Section 179. Therefore, the excess amount of $50,000 ($3,100,000 − $3,050,000) will reduce the available Section 179 deduction to $1,170,000 ($1,220,000 − $50,000). Jeremiah may expense $1,170,000 under Section 179 and must capitalize the remaining $1,930,000 ($3,100,000 − $1,170,000) and recover it through MACRS depreciation. c. The purchase price of $4,300,000 exceeds the threshold of $3,050,000 for qualifying purchases under Section 179 by $1,250,000 which eliminates all the maximum $1,220,000 Section 179 deduction potential. Jeremiah must capitalize $4,300,000 and recover it through MACRS depreciation.

Time On Task: 6 minutes 11) Title: Application Problem 11 Difficulty: Hard Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: a. The firm can deduct the entire $125,000 as a Section 179 expense. Taxable income limitation does not apply. b. The firm can deduct only $110,000 as a Section 179 expense because of the net income limitation. The firm can carry forward the remainder of $15,000 indefinitely. c. The firm does not qualify for a current Section 179 expense because the firm had an operating loss. The firm can carry forward the unused Section 179 expense of $125,000 indefinitely. Taxable income limitation applies.

Time On Task: 9 minutes 12) Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: a. Chase can deduct $525,000 in 2024. In 2023, Chase was able to use $30,000 of the available $55,000 Section 179 deduction leaving a carryforward of $25,000 to 2024.

Chase’s Section 179 deduction for 2024 is $525,000 ($500,000 + $25,000 carryforward from 2023) which is less than the Section 179 limit of $1,220,000. The 2024 profit before the Section 179 deduction is $2,000,000 so the taxable income limitation does not apply.

b. Chase can deduct $1,220,000 in 2024. In 2023, Chase was able to use $30,000 of the available $55,000 Section 179 deduction leaving a carryforward of $25,000 to 2024.

Chase’s qualifying cost for Section 179 is $1,225,000 ($1,200,000 + $25,000 carryforward from 2023). However, the limit for Section 179 is $1,220,000 for 2024.

Chase has a Section 179 deduction of $1,220,000 in 2024 and a carryforward of $5,000.

Time On Task: 8 minutes 13) Title: Application Problem 13 Difficulty: Hard Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: a. Company Q’s total cost recovery for 2024 would be $850,000. The business is allowed to recover the entire purchase price by electing Section 179, or by using a combination of bonus depreciation up to 60% of the cost and Section 179. b. Company Q’s total cost recovery for 2024 would be $1,850,000. The business is allowed to recover the entire purchase price by using a combination of bonus depreciation up to 60% of the cost and Section 179. Bonus depreciation for 2024 is $1,110,000 ($1,850,000  60%). If Section 179 is elected, the Section 179 deduction is $740,000 ($1,850,000 − $1,110,000). Section 179 business income limitation does not apply. c. Company Q’s total cost recovery for 2024 would be $2,900,000 determined as follows. To maximize the cost recovery deduction, Q will use a combination of bonus depreciation up to 60% of the cost, MACRS depreciation, and Section 179.

Bonus: Bonus depreciation for 2024 would be $2,310,000 ($3,850,000  60%).

Section 179 and MACRS: The Section 179 expense is limited to Q’s business net income which must be reduced for bonus depreciation and MACRS before the limitation is applied.

Because the purchase price of the equipment is greater than the threshold of $3,050,000, the Section 179 expense available is reduced to $420,000 [$1,220,000 – ($3,850,000 – $3,050,000)] which Q elects to expense.

The amount of basis left to depreciate under MACRS is computed as follows: Purchase price Less: Bonus Less: Section 179 Remaining basis

$3,850,000 (2,310,000) ( 420,000) $1,120,000

MACRS depreciation this year is $224,000 ($1,120,000 × 20%).

The $420,000 Section 179 expense is limited to business net income computed after bonus depreciation and MACRS have been deducted, as follows: Original business net income Less: Bonus depreciation Less: MACRS Business net income for Section 179

$2,900,000 (2,310,000) ( 224,000) $ 366,000

Because of the business income limitation, Company Q can deduct only $366,000 of Section 179. The remaining Section 179 of $54,000 ($420,000 − $366,000) can be carried forward.

The asset’s remaining MACRS depreciable basis of $896,000 ($1,120,000 − $224,000) will be recovered over the remaining recovery period.

The total recovery this year, and remaining basis for future years, are:

Bonus depreciation MACRS Section 179 Total

Recovery $2,310,000 224,000 366,000 $2,900,000

Future Years $896,000 54,000 $950,000

Time On Task: 12 minutes 14) Title: Application Problem 14 Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: The new interior heating and cooling system and the new fire alarm system qualify as Qualified Improvement Property (QIP). QIP is an improvement to the interior portion of nonresidential real property after the building has been placed in service. Taxpayers can depreciate QIP using the straight-line method over 15 years, using the half-year convention. QIP is also eligible for Section 179 expensing and bonus depreciation, although other types of realty are not.

Total cost of qualifying improvements $1,400,000 Section 179 ceiling (1,220,000) Adjusted basis $ 180,000 S/L depreciation (15 yr.)

$

*S/L depreciation (15 year) = $6,000 ($180,000  1/15  ½ year)

6,000*

Total cost recovery is $1,226,000 ($1,220,000 Section 179 + $6,000 MACRS) Time On Task: 6 minutes 15) Title: Application Problem 15 Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: a. Passenger automobiles have a limit on how much depreciation can be taken in each year. The limit for the first year for automobiles purchased in 2024, assuming bonus depreciation is not used, is $12,400. Regular MACRS depreciation is $18,400 ($92,000  20%). The cost recovery deduction is the lesser of these two amounts, or $12,400. b. Passenger automobiles have a limit on how much depreciation can be taken in each year. The limit for the first year for automobiles purchased in 2024 is $12,400. If bonus depreciation is elected, the first-year auto limit is $20,400 ($12,400 + $8,000). Therefore, Blackhawk can deduct $20,400.

Time On Task: 6 minutes 16) Title: Application Problem 16 Difficulty: Easy Learning Objective 1: 13.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.2 Solution: b. and d. Only the automobiles are listed assets. It does not matter if the business use is less than or greater than 50% in determining whether the asset is a listed asset. The business use percentage does affect how the automobile will be depreciated, as the business use must be greater than 50% for regular MACRS depreciation to be used.

Time On Task: 3 minutes 17) Title: Application Problem 17 Difficulty: Hard Learning Objective 1: 13.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 13.2 Solution:

Because this is a large SUV (greater than 6,000 pounds), the luxury automobile rules do not apply. The maximum cost that can be depreciated is $48,750 ($65,000  75%) because the business use percentage is 75%. Desiree can elect Section 179 expensing for $22,875 ($30,500 × 75%). Desiree must multiply the remaining cost of $25,875 ($48,750 − $22,875) by 60% for the bonus percentage, so her bonus depreciation is $15,525 ($25,875 × 60%). The remaining cost of $10,350 ($48,750 − $22,875 − $15,525) can be depreciated using the MACRS rules for 5-year property. The MACRS depreciation for the first year is $2,070 ($10,350 × 20%). The total depreciation expense claimed for 2024 is $40,470 ($22,875 + $15,525 + $2,070).

Time On Task: 6 minutes 18) Title: Application Problem 18 Difficulty: Hard Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: Victor must use the ADS system for depreciating his car because the car’s business use percentage does not exceed 50%. Victor’s car is not eligible for Section 179 or bonus depreciation. Automobiles are 5-year property for ADS so straight-line deprecation is 20% per year (100%/5 years). The half-year convention also applies, so Victor’s total cost recovery will be: $40,000/ 5 years  45% business use  1/2 = $1,800.

You can also use MACRS Table 5: $40,000  10%  45% business use = $1,800.

Time On Task: 5 minutes 19) Title: Application Problem 19 Difficulty: Hard Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: a. Betsy would be able to deduct $9,300, the lesser of: $9,375 ($62,500  20% 5-year percentage (MACRS Table 1)  75% business use), or

$9,300 ($12,400 Automobile limit  75% business use) b. Because the business use percentage no longer exceeds 50%, there are three adjustments to the depreciation calculation.

1. Depreciation for 2025 must be computed using the ADS straight-line method.

Automobiles are 5-year property so the ADS percentage for the 2nd year of the asset’s life is 20% (MACRS Table 5). The depreciation deduction is $5,000, the lesser of: $5,000 ($62,500  20%  40%), or $7,920 ($19,800*  40%). *$19,800 is the annual limit on luxury automobiles for their second year if purchased in 2024.

2. Depreciation for all future years for this automobile will be computed using ADS straight-line depreciation.

3. The depreciation taken in 2024 must be recomputed using the straight-line method with a half-year convention (or 10% as shown in MACRS Table 5). The excess depreciation claimed in 2024 must be recaptured as ordinary income. $62,500  20%  ½ year  75% = $4,688 Actual depreciation claimed in 2024 ADS Straight-line depreciation for 2024 Excess depreciation recaptured as income in 2025 Time On Task: 10 minutes

$9,300 (4,688) $4,612

20) Title: Application Problem 20 Difficulty: Hard Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: The $60,000 ($5,000  12) is treated as rent expense each year and is deductible. The leasehold improvements are treated as QIP property and depreciated over 15 years, even though the lease is for only 10 years. At the end of the 10 years, if Keisha and Dan do not renew their lease, then the leasehold improvements they paid for will revert to the lessor. Keisha and Dan will be able to deduct the remaining basis in the improvements as a Section 1231 loss.

Time On Task: 6 minutes

21) Title: Application Problem 21 Difficulty: Hard Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.2 Solution: In 2024, Jackson would be able to deduct $14,280, the lesser of: $27,300 ($65,000  60% bonus  70% business use) $14,280 [$12,400 + $8,000) Automobile limit  70% business use] In 2025, Jackson must make a safe harbor election and adjust the basis of the automobile if any depreciation is to be claimed. The remaining basis after 2024 is $50,720 ($65,000 − $14,280). In 2025, Jackson will be able to deduct $12,984, the lesser of: $12,984 ($50,720  32% MACRS (Table 1, 2025)  80% business use) $15,840 [$19,800 Automobile limit  80% business use] Time On Task: 8 minutes 22) Title: Application Problem 22 Difficulty: Medium Learning Objective 1: 13.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.3 Solution: MaryJane may amortize the patent over 17 years beginning in August of the current year. Her amortization deduction is $184 ($7,500/204 months  5 months).

Time On Task: 4 minutes 23) Title: Application Problem 23 Difficulty: Medium Learning Objective 1: 13.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.3 Solution: a. Mark can deduct amortization expense of:

Franchise: $100,000/15 years  8/12 = $4,444 Trade name: $40,000/15 years  8/12 = 1,778 Total amortization $6,222 b.

Amount realized Less: Adjusted basis Realized loss

$ 25,000 ( 27,500) ($ 2,500)

Because Mark still owns the franchise, the realized loss cannot be recognized, and the $2,500 disallowed loss is added to the remaining basis of the franchise.

Time On Task: 6 minutes 24) Title: Application Problem 24 Difficulty: Medium Learning Objective 1: 13.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.3 Solution: Maisy’s total amortization expense would be $6,250: Patent: $100,000/15 years  5/12 months = $2,778 Goodwill: $125,000/15 years  5/12 months = $3,472 Time On Task: 5 minutes 25) Title: Application Problem 25 Difficulty: Hard Learning Objective 1: 13.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.4 Solution: The annual cost depletion deduction = (Initial cost less accumulate depletion)/ Estimated total units in the ground at the beginning of the year  Units of production sold during the year. a. $230,000/1,000  350 = $80,500 annual cost depletion b. ($230,000 − $80,500)/800  200 = $37,375 annual cost depletion Time On Task: 6 minutes 26) Title: Application Problem 26

Difficulty: Hard Learning Objective 1: 13.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 13.4 Solution: In Year 1, Buy Gold Company’s percentage depletion is $75,000.

Gross income $500,000 Statutory percentage  0.15 Percentage depletion $75,000 Percentage depletion cannot exceed 50% of the company’s taxable income before the depletion deduction, and it does not.

Gross Income Less: Expenses Taxable Income

$500,000 ( 200,000) $300,000  50% $150,000

The annual cost depletion deduction = (Initial cost less accumulate depletion)/ Estimated total units in the ground at the beginning of the year  Units of production sold during the year. $230,000/1,000  350 = $80,500 annual cost depletion Buy Gold Company can deduct $80,500, the greater of cost depletion ($80,500) or percentage completion ($75,000).

In Year 2, Buy Gold Company’s percentage depletion is $45,000 Gross income $300,000 Statutory percentage  0.15 Percentage depletion $ 45,000 Percentage depletion cannot exceed 50% of the company’s taxable income before the depletion deduction, and it does not.

Gross Income Expenses Taxable Income

$300,000 ( 160,000) $140,000  50% $ 70,000

The annual cost depletion deduction = (Initial cost less accumulate depletion)/ Estimated total units in the ground at the beginning of the year  Units of production sold during the year.

($230,000 − $80,500)/800  200 = $37,375 annual cost depletion Buy Gold Company can deduct $45,000, greater of cost depletion ($37,375) and percentage completion ($45,000).

Time On Task: 10 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Hard Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 13.1 Solution: Thomas should purchase the tables in Year 1. The tables are 7-year property.

Alternative 1—Purchase at the end of Year 1: In computing the cash flow for each alternative, the $45,000 cost of the tables should be considered. However, since this cost is $45,000 for both alternatives, it is not included in the analysis below.

If he purchases the tables at the end of Year 1, the mid-quarter convention will apply because these are the only assets purchased in Year 1. His depreciation for Year 1 and Year 2 is shown below.

Depreciation calculation: Year 1 $45,000  3.57% mid-quarter table (MACRS Table 2d) = $ 1,607 Year 2 $45,000  27.55% (MACRS Table 2d) = $12,398 Total Depreciation $14,005 When computing the cashflow, the revenue must be reduced for the taxes owed on the increased revenue using the marginal tax rate of 24%. The amount of taxes saved due to depreciation expense must also be considered.

Change in cashflow for Alternative 1: Increase in revenue Decrease in taxes due to depreciation: Total depreciation $14,005  Tax rate  24% Tax savings Increase in cash flow

$ 6,840 [$9,000  (100% – 24%)]

3,361 $10,201

Alternative 2—Purchase at the beginning of Year 2: If the tables are purchased in the first quarter of Year 2, the half-year convention is used to compute depreciation.

Depreciation calculation: Year 2

$45,000  14.29% half-year table (MACRS Table 1) = $6,431

When computing the cashflow, the revenue must be reduced for the taxes owed on the increased revenue using the marginal tax rate of 24%. The amount of taxes saved due to depreciation expense must also be considered.

Change in cashflow for Alternative 2: Increase in revenue Decrease in taxes due to depreciation: Total depreciation  Tax rate Tax savings Increase in cash flow

$ 5,320 [$7,000  (100% – 24%)] $6,431  24% $1,543 $ 6,863

Alternative 1 provides the higher cashflow over Years 1 and 2 combined than Alternative 2 by $3,338 ($10,201 − $6,863). The increased cash flow is due to larger depreciation deductions for Alternative 1, and the new displays also increased his revenue by an additional $2,000 in Year 1 over what it would have been without the new displays.

Time On Task: 15 minutes 2) Title: Tax Planning Problem 2 Difficulty: Hard Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 13.1 Solution: a.

Asset

Placed in Service Computers March 10 Furniture March 10 Equipment April 15 Total second year depreciation

Cost $25,000 $40,000 $50,000

Recovery Period 5 years 7 years 7 years

MACRS Depreciation $ 8,000 ($25,000  32%, half yr.)

9,796 ($40,000  24.49%, half yr.)

12,245 ($50,000  24.49%, half yr.) $30,041

Depreciation is the greater of allowed or allowable. Go Green Company should have taken depreciation expense in its first year of operations. Even though depreciation was not taken, this does not affect the result of calculating depreciation expense in the second year using the MACRS Table 1 percentages for Year 2. b. The basis for the computers at the end of the second year of operations is: Year 1 $25,000  20% = Year 2 $25,000  32% = Total accumulated depreciation

$ 5,000 8,000 $13,000

Adjusted basis = $12,000 ($25,000 − $13,000) c. You should recommend amending the prior year’s tax return before the filing of the second year’s tax return to correctly deduct depreciation expense for the first year of operations. The asset’s basis must be reduced by the depreciation expense allowed in Year 1, so Go Green Company should get the benefit of the depreciation expense deduction for Year 1.

Time On Task: 15 minutes 3) Title: Tax Planning Problem 3 Difficulty: Hard Learning Objective 1: 13.2 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 13.2 Solution: a. The total cost recovery for all three asset purchases if the machinery is purchased in September is $44,725.

Asset

Placed in Cost Service Furniture February 10 $100,000 Computers July 29 $ 45,000 Machinery September 30 $150,000 Total depreciation

Recovery Period 7 years 5 years 7 years

Depreciation $14,290 ($100,000  14.29%) $ 9,000 ($45,000  20%) $21,435 ($150,000  14.29%) $44,725

b. The total cost recovery for all three asset purchases if the machinery is purchased in October is $37,105.

Asset Furniture Computers Machinery

Placed in Service February 10 July 29 October 1

Cost $100,000 $ 45,000 $150,000

Recovery Period 7 years 5 years 7 years

Depreciation $25,000 ($100,000  25%, 1st qtr.)

6,750 ($45,000  15%, 3rd qtr.)

5,355 ($150,000  3.57%, 4th qtr.)

Total depreciation

$37,105

When the machinery was purchased in October, the mid-quarter convention applied because more than 40% of the total assets were purchased and placed in service in the 4th quarter. $150,000 cost of new machinery > $ 118,000 ($295,000 total purchase of tangible personalty  40%). This affected the depreciation calculation for the furniture and computers as well. c. The machinery should be purchased on September 30 because it provides $7,620 more of total depreciation expense ($44,725 − $37,105).

Time On Task: 15 minutes 4) Title: Tax Planning Problem 4 Difficulty: Hard Learning Objective 1: 13.4 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 13.4 Solution: Cost method Year 1 125 tons  $475,000 (cost)/500 tons = Year 2 150 tons  $356,250 ($475,000 − $118,750)/375 tons) =

$118,750 $142,500

Percentage completion method (lower of column 1 or 2)

Year 1 Year 2

(1) (5%  Gross Income) $100,000 (5%  $2,000,000) $125,000 (5%  $2,500,000)

(2) Taxable Income Limit (50%) $53,750 ($107,500  50%) $57,500 ($115,000  50%)

Comparison: Depletion is the larger amount of the two methods.

Year 1 $118,750 (Cost depletion) Year 2 $142,500 (Cost depletion) Archie is allowed total depletion for Years 1 and 2 of $261,250 ($118,750 + $142,500).

Time On Task: 15 minutes Communication Problem 1.

Title: Communication Problem: Purchasing Automobiles vs. SUVs Difficulty: Medium Learning Objective 1: 13.2 Standard 1: AACSB || Communication

Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 13.2 Solution: Hello Jacob, Thank you for giving me the opportunity to provide some insight into the deductibility of the automobiles or large SUVs that you are considering purchasing. Let’s begin by discussing the deductible first-year expense for the automobiles. Depreciation deductions are computed using the MACRS rules. Passenger automobiles are also subject to a depreciation limit for each year they are in service. Your business can deduct the lesser of the depreciation deduction under MACRS or the automobile depreciation limit ($12,400). Bonus depreciation allows 60% depreciation for many assets purchased in 2024, but for the purchase of business-use passenger automobiles, it is limited to $8,000. Unless you elect to not have bonus depreciation apply, you would be able to deduct $20,400 ($12,400 + $8,000) for each auto purchased in Year 1.

If you choose to purchase large SUVs for your salespeople, the limitations that apply for passenger automobiles do not apply. The amounts for 2024 are as follows:

SUV

Cost $65,000

MACRS $13,000 ($65,000  20%)

Auto limit N/A

Deduction $13,000

Initially, the passenger automobiles look like the better choice. But, good news for large SUVs, 60% bonus depreciation is allowed in 2024. Unless you elect to not have bonus depreciation apply, you would be able to deduct $39,000 ($65,000  60%) plus MACRS depreciation on the remaining basis in 2024 for each SUV purchased.

Based solely on tax implications, I would recommend purchasing SUVs for your salespeople.

This is because, although the upfront cost is $10,000 more per vehicle, being able to deduct 60% of the cost and MACRS depreciation in 2024 far outweighs this difference in cost. You should also consider non-tax factors such as insurance and operating costs before making a decision.

Please let me know if you have any questions.

Sincerely, Carnes & Youngberg, CPAs Time On Task: 15 minutes Ethics Problem 1) Title: Ethics Problem: Incorrect Depreciation Determined on Previous Returns Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 13.1

Solution: Circular 230 §10.22 (a)(2), Diligence as to accuracy, states that a practitioner must exercise due diligence in determining the correctness of written representations made by the practitioner to the Department of Treasury. Also, Statement on Standards for Tax Services No. 1.2.6. Knowledge of Errors, "A member should promptly inform a taxpayer upon becoming aware of the taxpayer’s failure to file a required return, [or] an error in a previously filed return." It is your responsibility to your client and to your firm to bring the error to your partner’s attention even if you feel uncomfortable having the conversation. Corrective action should be taken to ensure that the tax returns reflect the proper accumulated depreciation expense and adjusted basis for when the asset is sold. You should promptly inform the client that an improper method of accounting was used, and Form 3115 (Application for Change in Accounting Method) is needed to correct the error and report the correct depreciation.

Time On Task: 12 minutes Tax Compliance and Reporting Problem 1) Title: Tax Compliance and Reporting Problem: Reporting of Depreciation Expense Difficulty: Medium Learning Objective 1: 13.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 13.1 Solution:

Asset Delivery Truck Office Furniture Office Equipment Audi A4 Sedan Total

Date Purchased 10/27/2024 08/10/2024 05/05/2024 03/09/2024

Mid-Qtr. Cost Depreciation Calculation $38,000 $ 1,900 $38,000  5% (4th qtr., 5 yr.)

8,000 857 $8,000  10.71% (3rd qtr., 7 yr.)

6,000 1,500 $6,000  25% (2nd qtr., 5 yr.)

40,000 9,800 $40,000  35%  70% (1st qtr., 5 yr.) $92,000 $14,057

The mid-quarter convention must be used to determine depreciation because more than 40% of the assets were purchased and placed in service in the fourth quarter. The total purchase price of the assets was $92,000 and the Delivery Truck was purchased in the fourth quarter for $38,000.

41.3% ($38,000/$92,000) is greater than 40%. The mid-quarter tables (MACRS Table 2) must be used for each asset purchased and placed in service in 2024.

The Audi automobile has a limit on how much depreciation can be taken each year. The luxury automobile limit for autos purchased in 2024 is $12,400 for the first year when no bonus depreciation has been elected. But Peter is using the automobile only 70% for business, so the maximum depreciation is limited to $8,680 ($12,400  70%). MACRS mid-quarter depreciation for the Audi is $14,000 ($40,000  35%, 1st qtr., 5 yr.). This must be reduced for the 70%

business use to $9,800 ($14,000  70%). Peter is able to deduct the lesser of the MACRS midquarter depreciation deduction or the automobile limit amount. Peter is allowed to deduct $8,680 for the Audi. [[COMP: Use high-res PDF version for the below form; see submitted file "Carnes_I2025_Ch13_SM_TaxComplianceAndReporting_Form 4562 2023 Hare.pdf"]]

Time On Task: 15 minutes Excel Problem

1) Title: Excel Problem: Using Excel to Calculate Cost Recovery Difficulty: Hard Learning Objective 1: 13.1, 2 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 13.1,2 Solution a.

1. The allowable Section 179 expense must be reduced because the total purchases of tangible personalty exceed $3,050,000. Section 179 allowed in 2024 = $1,070,000 [$1,220,000 − ($3,200,000 − $3,050,000)].

2. MACRS depreciation = $304,377 [($3,200,000 − $1,070,000)  14.29%].

3. Total cost recovery in 2024 = $1,374,377 ($1,070,000 + $304,377).

4. The remaining basis will be recovered over the next 6.5 years. b.

1. Section 179 initially allowed in 2024 = $1,070,000 [ $1,220,000 − ($3,200,000 − $3,050,000)].

2. MACRS depreciation = $304,377 [($3,200,000 − $1,070,000)  14.29%].

3. Business income must be reduced for the MACRS depreciation. Business income limitation = $470,623 ($775,000 − $304,377).

4. Section 179 allowed after business income limitation = $470,623.

5. Total cost recovery = $ 775,000 ($470,623 + $304,377).

6. Remaining Section 179 to carryforward to 2025 = $ 599,377 ($1,070,000 − $470,623).

7. The remaining basis will be recovered through MACRS over the next 6.5 years. c. Yes, Section 179 is reduced in parts a and b due to purchases being in excess of the threshold of $3,050,000. It is further reduced in part b due to business income limitations.

Marcos needs to estimate his business income in future years to see if he will be able to absorb the Section 179 carryforward of $599,377 from 2024.

Time On Task: 20 minutes [See submitted file: "Carnes_I2025_Ch13_SM_Excel problem.xlsx"] Part A

Input Area: Cost of Furniture & Fixtures 2024 Taxable Income Before Depreciation Section 179 Election made in 2023 Calculation: Part 1: 2024 Max Allowable Section 179 Election Part 2: Actual Section 179 Utilized in 2023 2024 MACRS Depreciation Total Cost Recovery in 2024 2024 Section 179 Carryforward

3,200,000 1,500,000 1,220,000

1,070,000

7 Year MACS Table -HY Year 1 14.29% Year 2 24.49% Year 3 17.49% Year 4 12.49% Year 5 8.93% Year 6 8.92% Year 7 8.93% Year 8 4.46%

1,070,000 304,377 1,374,377 -

Chapter 13: Cost Recovery of Property Input Area: Cost of Furniture & Fixtures 2024 Taxable Income Before Depreciation Section 179 Election made in 2023 Calculation: Part 1: 2024 Max Allowable Section 179 Election Part 2: Actual Section 179 Utilized in 2023 2024 MACRS Depreciation Total Cost Recovery in 2024 2024 Section 179 Carryforward

Part B

3200000 1500000 1220000

=1220000-(B4-3050000) =MIN(MIN(B6,B10),B5-B13) =ROUND((B4-MIN(B6,B10))*VLOOKUP("Year 1",$D$4:$E$11,2),0) =B12+B13 =B10-B12

Input Area: Cost of Furniture & Fixtures 2024 Taxable Income Before Depreciation Section 179 Election made in 2023

3,200,000 775,000 1,220,000

Calculation: Part 1: 2024 Max Allowable Section 179 Election Part 2: Actual Section 179 Utilized in 2023 2024 MACRS Depreciation Total Cost Recovery in 2024 2024 Section 179 Carryforward

1,070,000

7 Year MACS Table -HY Year 1 14.29% Year 2 24.49% Year 3 17.49% Year 4 12.49% Year 5 8.93% Year 6 8.92% Year 7 8.93% Year 8 4.46%

470,623 304,377 775,000 599,377

CPA Exam: Task-Based Simulation 1) Title: CPA Exam: Task-Based Simulation: Computing Depreciation Difficulty: Hard Learning Objective 1: 13.1,2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 13.1,2 Solution: 1.

A Using the tables provided in the Exhibits tab, calculate the MACRS depreciation expense, assuming no Section 179

B $ 179,409

election and no bonus depreciation.

Using the tables provided in the Exhibits tab, calculate the total cost recovery deduction if SRU elects Section 179 (apply to 7year property first) and bonus depreciation.

If SRU had net income of $250,000 before purchase of the assets, what is SRU's taxable income, assuming Section 179 and bonus are elected?

If the machinery was purchased on December 10 instead of August 10, calculate the MACRS depreciation expense on all four assets, assuming no Section 179 election is made, and bonus depreciation is not taken.

$1,233,940

$0

$88,845

MACRS depreciation expense:

Asset

Date Cost Purchased

% From Table MACRS

Truck – 5 year

$ 35,000

1/8/2024

Equipment – 7 year

233,000

6/5/2024 14.29%

Computer – 5 year

2,500

Machinery – 7 year

970,000

Total

7/29/2024

20% $

7,000 33,296

20%

500

8/10/2024 14.29%

138,613

$1,240,500

$179,409

Using the MACRS half-year convention tables and appropriate recovery period, the total MACRS depreciation expense is $179,409. The table already accounts for the half-year convention in year one of the recovery.

Total cost recovery using Section 179 and bonus:

Asset

Remaining Basis

Bonus Remaining (60%) Basis

Cost

Section 179

Truck – 5 year

$ 35,000

$ 17,000

$ 18,000 $ 10,800

Equipment – 7 year

233,000

233,000

0

0

Computer – 5 year

2,500

0

2,500

1,500

Machinery – 7 year

970,000

970,000

0

0

$1,240,500

$1,220,000

Total

% From Table MACRS Total

$7,200

20%

$1,440

0 14.29%

0

1,000

20%

200

0 14.29%

0

$12,300

$1,640 $1,233,940

Section 179 allows a business to expense rather than capitalize a limited dollar amount of property purchased in a year. The maximum deduction for 2024 is $1,220,000. To minimize taxes, Section 179 is first elected for 7-year property and then for 5-year property.

Several recent Congressional acts have allowed businesses to elect bonus depreciation on qualified property acquisitions. The bonus depreciation rate for 2024 is 60% for the remaining basis of the assets. Schools R Us is allowed a total cost recovery deduction of $1,233,940. Bonus depreciation can be used for new and used property, so the computer is eligible for bonus depreciation.

SRU's taxable income: Profit before any depreciation or Section 179

$250,000

Less: Bonus and MACRS

(13,940)

Available profit

236,060

Section 179 deduction

(236,060)

Taxable Income

$

0

Section 179 is limited to taxable business income computed without regard to the deduction. The remaining $983,940 ($1,220,000 - $236,060) of Section 179 is carried forward to future years.

(Note: This problem illustrates that Section 179 is deducted AFTER bonus and regular MACRS. Because bonus depreciation is 60% for 2024, a better strategy for the taxpayer would be to not elect Section 179. Then 60% of the assets would be expensed using bonus depreciation plus

allowable MACRS depreciation, and the taxable income limitation would not apply. There is no taxable income limitation for bonus depreciation.)

Machinery purchased on December 10:

Asset

Date Quarter Cost Purchased Purchased

Percentage from Mid-Qtr Table MACRS

Truck – 5 year

$ 35,000

1/8/2024 First

35%

$12,250

Equipment – 7 year

233,000

6/5/2024 Second

17.85%

41,591

Computer – 5 year

2,500

7/29/2024 Third

15%

$ 375

970,000 12/10/2024 Fourth

3.57%

34,629

Machinery – 7 year Total

$1,240,500

Midquarter applies

0.7819

$88,845

The half-year convention is subject to an important exception. If more than 40% of the personalty is purchased and placed in service in the 4th quarter, then the mid-quarter convention applies with respect to all personalty acquired during the taxable year. For SRU, 78.19% of the assets are placed in service in the 4th quarter ($970,000/$1,240,500). Therefore, the assets are assumed to be placed in service midway through the quarter purchased. The mid-quarter convention tables must be used for all four assets purchased.

Time On Task: 25 minutes

Chapter 14—Taxation of Assets Used in a Trade or Business End of Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Medium Learning Objective 1: 14.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.1 Solution: If the land held for investment is sold, it will have a capital gain or loss because it is a capital asset. If the land used in a trade or business is sold, it will result in a Section 1231 gain or loss.

This Section 1231 gain or loss will enter the Section 1231 gain netting process to determine its final character.

Time On Task: 3 minutes 2) Title: Discussion Question 2 Difficulty: Medium Learning Objective 1: 14.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.1 Solution: When an asset is sold, the character of the gain or loss is important because that determines how it will be taxed. An ordinary gain will be taxed at the taxpayer’s marginal tax rate, and an ordinary loss can be used to offset other types of income without limitation. A capital gain will be taxed at a preferential rate if the asset was held long-term, and as ordinary income if not. A capital loss has a maximum deduction of $3,000 per year with an indefinite carryforward of the remainder. A net Section 1231 gain is treated as a long-term capital gain, and a net Section 1231 loss is treated as an ordinary loss.

Time On Task: 3 minutes 3) Title: Discussion Question 3 Difficulty: Easy Learning Objective 1: 14.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.2 1

Solution: A taxpayer must hold the depreciable asset or realty used in a trade or business long-term for it to be considered a Section 1231 asset. A long-term asset is any asset held more than 365 days (held more than one year).

Time On Task: 2 minutes 4) Title: Discussion Question 4 Difficulty: Medium Learning Objective 1: 14.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.3 Solution: A business-use asset held long-term is a Section 1231 asset. If this is the only asset sold in the current year, a net Section 1231 asset sold at a loss is characterized as an ordinary loss.

Time On Task: 3 minutes 5) Title: Discussion Question 5 Difficulty: Hard Learning Objective 1: 14.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.3 Solution: When a taxpayer sells business-use assets, recognized gains and losses occur. The taxpayer nets all Section 1231 gains and losses. If a net Section 1231 gain results, the taxpayer must look back five years to determine if any net Section 1231 losses occurred that were treated as ordinary losses. To the extent of those previous ordinary losses, the current Section 1231 gain is treated as ordinary. Any remaining Section 1231 gain is treated as a long-term capital gain.

Time On Task: 4 minutes 6) Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 14.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.3 Solution: The five-year lookback rule applies only to net Section 1231 gains generated in the current year.

A net Section 1231 loss is always an ordinary loss in the current year.

2

Time On Task: 2 minutes 7) Title: Discussion Question 7 Difficulty: Medium Learning Objective 1: 14.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.4 Solution: Section 197 intangible assets (e.g., patents, copyrights, purchased goodwill) are amortized, and amortization expense is deducted each year. When a Section 197 asset is sold, Section 1245 recapture applies to the lesser of the recognized gain or the amortization taken on the asset. If there is any remaining gain after recapture, it is treated as a Section 1231 gain because the asset was used in a trade or business and held for more than one year.

Time On Task: 3 minutes 8) Title: Discussion Question 8 Difficulty: Medium Learning Objective 1: 14.4, 5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.4, 5 Solution: A Section 1245 asset is a tangible, depreciable, or amortizable property other than land or buildings that is used in a trade or business and has been owned for more than one year. If a Section 1245 asset is sold at a gain, the amount is characterized as ordinary to the extent of the accumulated depreciation taken, but not to exceed the recognized gain. This is referred to as Section 1245 depreciation recapture. If the gain is in excess of the accumulated depreciation, the remaining amount would be considered Section 1231, long-term capital gain. If a Section 1245 asset is sold at a loss, the recapture rules do not apply, and the loss is a Section 1231 loss.

A Section 1250 asset is a building used in a trade or business and owned for more than one year.

If a Section 1250 asset is sold at a gain, the amount is characterized as ordinary income to the extent of the excess of accelerated depreciation taken over what straight line depreciation would have been, but not to exceed the recognized gain. Under current law, a Section 1250 asset is depreciated using straight-line depreciation so there is no excess depreciation. The gain that is not subject to Section 1250 recapture is next treated as unrecaptured Section 1250 gain to the extent of straight-line depreciation. The remaining gain, if any, is treated as Section 1231 gain. If a Section 1250 asset is sold at a loss, the recapture rules do not apply, and the entire loss is characterized as Section 1231.

Time On Task: 5 minutes

3

9) Title: Discussion Question 9 Difficulty: Medium Learning Objective 1: 14.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.5 Solution: Unrecaptured Section 1250 gain represents the portion of gain that is attributable to straight-line depreciation taken on a building used in a trade or business. Gain attributable to unrecaptured Section 1250 gains is taxed at a maximum tax rate of 25%.

Time On Task: 3 minutes 10) Title: Discussion Question 10 Difficulty: Hard Learning Objective 1: 14.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.5 Solution: In the case of a sale of an asset that was received as a gift, the recapture potential carries over to the donee. The recapture provision does not apply to the donor. In the case of a sale of an asset that was received through inheritance, the recapture potential is eliminated. In the case of charitable contribution of property that would have generated depreciation recapture if it had been sold, the amount that would have been recaptured reduces the charitable contribution deduction. In the case of a sale of an asset that was received through certain tax-free exchanges, recapture potential carries over to the new owner with the property received in the exchange.

Time On Task: 4 minutes 11) Title: Discussion Question 11 Difficulty: Easy Learning Objective 1: 14.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.5 Solution: Form 4797 is used for sales of business use property. If the taxpayer has net Section 1231 gains, it is transferred to Form 1040, Schedule D. Time On Task: 1 minute Multiple Choice Questions 4

1) Answer: a-e Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 14.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.1 Solution: All of the above are considered Section 1231 assets.

A Section 1231 asset is a depreciable asset or land used in a trade or business that has been owned for more than one year.

Time On Task: 3 minutes 2) Answer: d Title: Multiple Choice Question 2 Difficulty: Easy Learning Objective 1: 14.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.1 Solution: The only correct answer is Land used as a parking lot adjacent to an office building.

The land is realty used in a trade or business and owned for more than one year. The accounts receivable and supplies are ordinary assets. The land held for investment and stock are capital assets.

Time On Task: 3 minutes 3) Answer: d Title: Multiple Choice Question 3 Difficulty: Medium Learning Objective 1: 14.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.1 Solution: The correct answer is Land/Parking – Section 1231 asset, Land/Investment – Capital asset.

The land that is used as a parking lot is used in the trade or business and held long-term and is classified as Section 1231 property. The land that is held for investment is a capital asset.

Time On Task: 3 minutes 5

4) Answer: b Title: Multiple Choice Question 4 Difficulty: Medium Learning Objective 1: 14.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.2 Solution: The correct answer is A Section 1245 asset can be a Section 1250 asset.

All of the answers are true except for answer b. An asset cannot be both a Section 1245 and Section 1250 asset. Section 1250 assets are buildings used in a trade or business and owned for more than one year. Section 1245 assets include all other types of depreciable property that are used in a trade or business and owned for more than one year. Land is realty and considered a Section 1231 asset if held more than one year.

Time On Task: 3 minutes 5) Answer: a Title: Multiple Choice Question 5 Difficulty: Medium Learning Objective 1: 14.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.3 Solution: The correct answer is Ordinary income – $18,000, Long-term Capital Gain – $12,000.

A gain is taxed as ordinary income to the extent of unrecaptured Section 1231 losses from the last five years. Year 4 had a net Section 1231 loss of $18,000 which is recaptured in Year 5. The remaining Year 5 net Section 1231 gain is long-term capital gain.

Time On Task: 5 minutes 6) Answer: c Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 14.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.4 Solution: The correct answer is $4,000.

6

Recognized gain is $4,000 (Amount realized $8,000 − Adjusted basis $4,000), recaptured to the extent of depreciation claimed of $6,000.

Time On Task: 4 minutes 7) Answer: b Title: Multiple Choice Question 7 Difficulty: Medium Learning Objective 1: 14.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.4 Solution: The correct answer is $1,711.

Recognized gain is $2,111 (Amount realized $4,000 − Adjusted basis $1,889), recaptured to the extent of the depreciation claimed of $1,711.

Time On Task: 4 minutes 8) Answer: a Title: Multiple Choice Question 8 Difficulty: Medium Learning Objective 1: 14.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.4 Solution: The correct answer is $0.

The recognized loss is ($300) (Amount realized $1,000 − Adjusted basis $1,300). Depreciation recapture does not apply to losses.

Time On Task: 3 minutes 9) Answer: c Title: Multiple Choice Question 9 Difficulty: Hard Learning Objective 1: 14.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.5 Solution: The correct answer is Unrecaptured Section 1250 gain at 25% rate − $40,000, Section 1250 recapture − $0.

7

There is no Section 1250 recapture on realty depreciated under the straight-line method. The unrecaptured Section 1250 gain is taxed at 25% to the extent of straight-line depreciation claimed.

Time On Task: 4 minutes 10) Answer: b Title: Multiple Choice Question 10 Difficulty: Medium Learning Objective 1: 14.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.5 Solution: The correct answer is $40,000.

The gain recognized is $335,000 (Amount realized $400,000 − Adjusted basis $65,000). The Section 1250 recapture is $40,000 (Accelerated depreciation $260,000 − Straight line depreciation $220,000). The straight-line depreciation of $220,000 is taxed at 25% and the remaining gain of $75,000 is Section 1231 gain.

Time On Task: 4 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Easy Learning Objective 1: 14.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.1 Solution: The football equipment is inventory and considered an ordinary asset.

Time On Task: 1 minute 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 14.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.2 Solution:

8

Plot 1 is Section 1231 because it will be used in her business. Plot 2 is capital because it is held for investment. Plot 3 is Section 1231 because it is used on the farm which is a business.

Time On Task: 2 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 14.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.3 Solution: The $22,000 Section 1231 gain is netted with the $11,000 Section 1231 loss. The net Section 1231 gain of $11,000 is a Section 1231 gain which is a long-term capital gain. The stock loss of $9,000 can be used to offset the capital gain resulting in a net long-term capital gain of $2,000.

Time On Task: 3 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 14.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 114.4 Solution: Amount realized $44,000 Less: Adjusted basis (15,000) ($75,000 − $60,000) Recognized gain $29,000 Section 1245 recapture = Lesser of: Recognized gain Depreciation taken

$29,000 or $60,000

All the $29,000 recognized gain will be characterized as ordinary income under the Section 1245 recapture provision.

Time On Task: 5 minutes 5) Title: Brief Exercise 5 Difficulty: Hard Learning Objective 1: 14.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.5 9

Solution: The gift does not subject Uncle Joey to the recapture provisions. The recapture potential carries over to Giada, the recipient donee.

Time On Task: 2 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium Learning Objective 1: 14.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 14.2 Solution: a. Ordinary b. Section 1231, Section 1245 c. Ordinary d. Section 1231, Section 1245 e. Ordinary, because the asset was not owned for more than one year f. Section 1231, Section 1245 g. Capital h. Ordinary Time On Task: 4 minutes 2) Title: Application Problem 2 Difficulty: Easy Learning Objective 1: 14.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.3 Solution: The $12,000 Section 1231 gain is netted with the $15,000 Section 1231 loss. The net Section 1231 loss of $3,000 is ordinary.

Time On Task: 3 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 14.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application 10

Section Reference 1: 14.3 Solution: Current AGI Ordinary income Less: Net Section 1231 loss Less: Stock loss Adjusted AGI

$120,000 6,000 ( 1,000) Treated as an ordinary loss ( 3,000) Capital loss deductible up to $3,000, carryforward of $1,000 $122,000

Time On Task: 5 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 14.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.3 Solution: The $45,000 gain from the land held for investment is a long-term capital gain because the land is an investment asset which is a capital asset.

The loss from the inventory of $23,000 is an ordinary loss because inventory is an ordinary asset.

The loss from the casualty is a $55,000 Section 1231 loss because the warehouse is a Section 1231 asset.

The gain from the sale of the parking lot of $20,000 is a Section 1231 gain. Because land is not depreciable, there is no depreciation recapture.

The $55,000 Section 1231 loss and the $20,000 Section 1231 gain are netted to produce a net Section 1231 loss. This loss is treated as an ordinary loss. Boris also has an ordinary loss from the inventory of $23,000, so his total ordinary loss is $58,000 ($23,000 + $35,000). Boris also has a long-term capital gain of $45,000.

Time On Task: 5 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 14.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.3 Solution: Asset Sales Price

Cost 11

Gain/loss

Character

Land held for investment $100,000 Land #1 used in her business $135,000 Land #2 used in her business $122,000

$ 74,000 $140,000 $115,000

$26,000 LT Capital gain ($ 5,000) ST Ordinary loss $ 7,000 LT Section 1231 gain

Land held for investment is always a capital asset.

Land used in a trade or business but held short-term is an ordinary asset. Therefore, the loss is ordinary.

The Section 1231 gain would be considered a long-term capital gain because there are no net Section 1231 losses from previous years.

Time On Task: 8 minutes 6) Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 14.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.3 Solution: Li has a net Section 1231 gain of $2,800 ($5,000 − $2,200) in Year 4. Because of the five-year lookback rule, Li must treat the Section 1231 gain in Year 4 as ordinary to the extent of the unrecaptured Section 1231 loss in Year 3. Therefore, Li has ordinary income of $1,000 and a long-term capital gain of $1,800.

Time On Task: 5 minutes 7) Title: Application Problem 7 Difficulty: Hard Learning Objective 1: 14.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.3 Solution: Because Rhys has a net Section 1231 gain in Year 10, he must look back for any unrecaptured net Section 1231 losses that were treated as ordinary in the previous five years.

Year 4 had a net Section 1231 loss of $2,000 that would have been treated as ordinary, and year 5 had the same for $1,500.

In Year 6, Rhys would have treated the entire $2,500 Section 1231 gain as ordinary due to the unrecaptured loss of $2,000 from Year 4 and $500 in Year 5. There is $1,000 of remaining unrecaptured losses from Year 5.

12

In Year 7, the net Section 1231 gain of $800 would also have been treated as ordinary due to the remaining $1,000 of unrecaptured losses from Year 5. This leaves $200 of unrecaptured loss from Year 5 to be dealt with for the next four years.

In Year 8, the $4,500 of net Section 1231 losses would have been treated as ordinary.

In Year 9, the net Section 1231 gain of $3,000 would have been ordinary due to the unrecaptured losses of $200 from Year 5 and $2,800 from Year 8. This leaves $1,700 of unrecaptured loss from Year 8 to be dealt with in Year 10.

In Year 10, the net Section 1231 gain of $7,000 would be considered $1,700 ordinary income due to the unrecaptured loss of $1,700 from Year 8 and $5,300 capital gain.

Year 4: Year 5: Year 6:

Net Section 1231 Ordinary Loss

Ordinary Income

$2,000 Loss $1,500 Loss $2,500 Gain

$2,500

LTCG Gain

$2,000 $1,500 Recaptured by $2,000 loss from Year 4 Recaptured by $500 loss from Year 5

Year 7:

$ 800 Gain

$800 Recaptured by $800 loss from Year 5

Year 8: Year 9:

$4,500 Loss $3,000 Gain

$4,500 $3,000 Recaptured by $200 loss from Year 5 Recaptured by $2,800 loss from Year 8

Year 10:

$7,000 Gain

$1,700

$5,300

Recaptured by $1,700 loss from Year 8

Time On Task: 12 minutes 8) Title: Application Problem 8 Difficulty: Medium Learning Objective 1: 14.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.3 Solution: a.

Amount realized $125,000 Less: Adjusted basis ( 138,000) Recognized loss ($ 13,000) The land was used in a trade or business and held long-term so the net Section 1231 loss would be recognized as an ordinary loss.

13

b.

Amount realized $150,000 Less: Adjusted basis (138,000) Recognized gain $ 12,000 The land was used in a trade or business and held long-term so the gain would be recognized as a Section 1231 gain. Because there were no other Section 1231 transactions this year, the net $12,000 Section 1231 gain is treated as a long-term capital gain. Section 1250 recapture does not apply because land is not depreciable. The lookback does not apply because there have been no Section 1231 losses in the previous five years.

Time On Task: 8 minutes 9) Title: Application Problem 9 Difficulty: Medium Learning Objective 1: 14.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.4 Solution: a.

Amount realized $28,000 Less: Adjusted basis ( 15,000) ($38,000 cost − $23,000 depreciation) Recognized gain $13,000 Section 1245 recapture = Lesser of: Recognized gain Depreciation taken

$13,000 or $23,000

All the $13,000 recognized gain will be characterized as ordinary income under the Section 1245 recapture provision. b.

Amount realized $49,000 Less: Adjusted basis (15,000) Recognized gain $34,000 Section 1245 recapture = Lesser of: Recognized gain Depreciation taken

$34,000 or $23,000

Of the $34,000 recognized gain, $23,000 is characterized as ordinary income to the extent of the accumulated depreciation taken and the remaining $11,000 is a Section 1231 gain. c.

Amount realized $12,000 Less: Adjusted basis ( 15,000) 14

Recognized loss

($ 3,000) (Section 1231 loss)

Section 1245 recapture does not apply to losses. The $3,000 recognized loss would be characterized as a Section 1231 loss. If this was the only asset sold during the current year, then the loss would be an ordinary loss.

Time On Task: 12 minutes 10) Title: Application Problem 10 Difficulty: Hard Learning Objective 1: 14.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.4 Solution: a.

Amount realized $25,000 Less: Adjusted basis ( 20,000) ($50,000 Cost − $30,000 Depreciation) Tax gain $ 5,000 Section 1245 recapture = Lesser of: Recognized gain of $5,000, or depreciation taken of $30,000. Sasha recognizes $5,000 of ordinary income. b. The $5,000 of recapture income is taxed at her marginal ordinary rate of 22%. The tax that is due is $1,100 ($5,000  22%).

Cash received from sale Less: Tax cost After tax cash flow Time On Task: 8 minutes

$25,000 ( 1,100) $23,900

11) Title: Application Problem 11 Difficulty: Medium Learning Objective 1: 14.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.4 Solution: Amount realized $65,000 Less: Adjusted basis (33,200) ($50,000 cost less $16,800 accumulated amortization) Recognized gain $31,800

15

A patent purchased as part of the acquisition of a business, rather than created by the owner, is a Section 1245 asset, so Section 1245 recapture applies. Section 1245 recapture is $16,800, the lesser of: Recognized gain Amortization taken

$31,800 or $16,800

The remaining gain of $15,000 is a Section 1231 gain because the asset is used in a trade or business and was owned for more than one year.

Time On Task: 8 minutes 12) Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 14.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.5 Solution: Amount realized $248,000 Less: Adjusted basis (198,000) ($232,000 cost − $34,000 accumulated depreciation) Recognized gain $ 50,000 The apartment building is realty, and subject to Section 1250 recapture. Section 1250 recapture is the lesser of: Recognized gain Accelerated depreciation in excess of straight line

$50,000 or $ 6,000

Daisy will have ordinary income of $6,000, $28,000 of unrecaptured Section 1250 gain, and Section 1231 gain of $16,000.

Recognized Gain $50,000 Section 1250 recapture

Unrecaptured Section 1250 gain

Section 1231 gain

Excess depreciation: $6,000

Straight-line depreciation: $28,000

Remaining gain: $16,000

Time On Task: 8 minutes 13) Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 14.5 16

Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.5 Solution: Amount realized: Cash Debt relief

$100,000 300,000 $400,000

Less: Adjusted basis: Cost Less: Accumulated Depreciation

$365,000 ( 47,000) (318,000) $ 82,000

Realized and recognized gain

Eric deducted straight line depreciation and therefore, has no Section 1250 recapture. The unrecaptured 25% gain is $47,000 and $35,000 is a Section 1231 gain. If this is the only Section 1231 asset sold this year, the $35,000 gain would be a long-term capital gain.

Recognized Gain $82,000 Section 1250 recapture

Unrecaptured Section 1250 gain

Section 1231 gain

Excess depreciation: $0

Straight-line depreciation: $47,000

Remaining gain: $35,000

Time On Task: 8 minutes 14) Title: Application Problem 14 Difficulty: Hard Learning Objective 1: 14.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 14.5 Solution: Latif will not recognize any taxable income on the receipt of the inheritance, but he will have a taxable gain when he sells the apartment building. Because Latif inherited the apartment building from his grandmother, his basis in the building is the fair market value as of the date of death.

His gain on the sale will be: Amount realized $650,000 Less: Adjusted basis (625,000) 17

Recognized gain

$ 25,000

The depreciation recapture potential does not carryover from the decedent to the beneficiary for assets received due to death. The depreciation recapture potential is eliminated at the death of the owner of the property. Therefore, the $25,000 gain is a Section 1231 gain.

Time On Task: 6 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Difficult Learning Objective 1: 14.1, 3, 4, 5 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 14.1, 3, 4, 5 Solution: Asset

Adjusted Depreciation Basis Gain/loss Character

Sales Price

Cost

Furniture Computers Artwork Machinery Building

$ 7,000 $ 2,500 $ 10,000 $ 8,000 $100,000

$10,000 $ 4,000 $12,000 $12,000 $75,000

$10,000 $ 3,000 N/A $ 2,000 $ 7,500

Stock

$ 60,000

$33,000

N/A

$ 0 $7,000 Ordinary (1) $ 1,000 $1,500 Ordinary (1) $12,000 ($2,000) LTCL $10,000 ($2,000) 1231 loss $67,500 $ 7,500 25% gain (2) $25,000 1231 gain (3) $33,000 $27,000 LTCG

(1) The furniture and computers were sold at a gain and subject to Section 1245 recapture.

Section 1245 recapture is equal to the lesser of recognized gain or accumulated depreciation taken. Because the gain for both of these asset sales is less than the depreciation taken, all of the gain is subject to Section 1245 recapture and considered ordinary.

(2) The unrecaptured Section 1250 (25%) gain is $7,500. The unrecaptured Section 1250 gain is equal to the straight-line depreciation claimed.

(3) The Section 1231 gain is $25,000 ($32,500 total gain − $7,500 unrecaptured Section 1250 gain).

Additional explanation: • • •

The artwork is a capital asset in Barret’s hands and the loss is a capital loss.

The machinery is a Section 1231 asset and sold at a loss, so the Section 1245 recapture rules do not apply.

The building is a Section 1231 asset but there would be no Section 1250 recapture because straight line deprecation would have been taken on this asset since it was purchased in 2012.

18

•

The stock is a capital asset resulting in a long-term capital gain.

Barret’s net profit before asset sales Plus: Ordinary income ($7,000 + $1,500) Plus: Net Section 1231 gain ($25,000 − $2,000) Plus: Net capital gain ($27,000 − $2,000) Plus: Unrecaptured Section 1250 gain Barret’s profit after asset sales

$350,000 8,500 23,000 25,000 7,500 $414,000

For advice, if Barret does sell the building this year, he may want to delay selling the machinery until next year. The building has a $25,000 Section 1231 gain and the machinery has a $2,000 Section 1231 loss. If both are sold this year, the loss is reducing Section 1231 gain that is treated as LTCG that is taxed at preferential rates. If the loss is recognized next year, it may be able to offset ordinary income which is taxed at higher rates. The sale of the artwork also results in a capital loss that would reduce the capital gain from the sale of stock. This sale could be delayed until next year because the $2,000 loss is less than the $3,000 capital loss limit for individuals and could all be deducted next year.

Time On Task: 20 minutes 2) Title: Tax Planning Problem 2 Difficulty: Difficult Learning Objective 1: 14.4 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 14.4 Solution: Dwayne is mistaken. He will have a recognized gain because his adjusted basis in the machinery and equipment has been reduced to zero by the depreciation claimed.

Amount realized Less: Adjusted basis Cost Less: Accumulated Depreciation Recognized gain

$500,000 $500,000 (500,000)

0 $500,000

Section 1245 recapture = Lesser of: Recognized gain $500,000 or Depreciation taken $500,000 Section 1245 recapture recharacterizes the gain from Section 1231 gain to ordinary. If recapture didn’t apply, the $500,000 gain could be taxed as long-term capital gain taxed at a preferential rate of 20% resulting in a tax of $100,000 ($500,000  20%). With a marginal tax rate of 37%, the depreciation deduction benefit would have been $185,000 ($500,000  37%). Dwayne would have benefitted by $85,000($185,000 − $100,000) simply due to the character difference of the 19

depreciation deduction versus the long-term capital gain. Congress created the recapture rules, so the $500,000 gain is taxed as an ordinary gain at 37%. Dwayne’s tax liability upon sale equals the tax benefit from the depreciation deductions that have been taken over the years the machinery and equipment have been used: $185,000.

Time On Task: 10 minutes 3) Title: Tax Planning Problem 3 Difficulty: Difficult Learning Objective 1: 14.5 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 14.5 Solution: If received as a gift: Sanjay will not recognize any taxable income on the receipt of the gift, but he will have a taxable gain when he sells the warehouse. Sanjay’s basis in the warehouse is the same as the donor, his uncle.

Amount realized $550,000 Less: Adjusted basis ( 279,000) (Cost $375,000 − Depreciation $96,000) Recognized gain $271,000 The Section 1250 depreciation recapture potential is transferred with the property to the donee for a gift and will affect the character of the $271,000 gain. There is no Section 1250 recapture because straight-line depreciation was claimed. However, the unrecaptured Section 1250 (25%) gain applies to the extent of the straight-line depreciation of $96,000. The remaining gain of $175,000 is a Section 1231 gain.

If received through inheritance: Sanjay will not recognize any taxable income on the receipt of the inheritance, but he will have a taxable gain when he sells the warehouse. Sanjay’s basis is the fair market value as of the date of death.

Amount realized Less: Basis (FMV as of date of death) Recognized gain

$550,000 ( 500,000) $ 50,000

When the warehouse is sold, it does not have depreciation recapture potential, as the depreciation recapture is eliminated at the death of the owner of the property and the gain will be a Section 1231 gain. Recapture potential does not transfer to the beneficiary when an asset is transferred due to death.

You should advise Sanjay to tell his uncle to not gift the property at this time. Rather, he should bequeath it to Sanjay in his will .

Time On Task: 12 minutes

20

4) Title: Tax Planning Problem 4 Difficulty: Difficult Learning Objective 1: 14.5 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 14.5 Solution: To properly advise DeMarcus, you must first calculate the character of the gain/loss if the assets are sold.

Adjusted Asset Sales Price Cost Depreciation Basis Gain/loss Building $100,000 $75,000 $5,000 $70,000 $30,000 Land

$ 25,000

$37,000

N/A

$ 37,000 ($12,000)

Character $5,000 25% gain $25,000 Section 1231 gain Section 1231 loss

If the two assets were sold in the same year, it would result in a net Section 1231 gain of $13,000 which would be treated as a long-term capital gain taxed at 20%. The $5,000 gain would be taxed at a maximum rate of 25%.

Unrecaptured Section 1250 (25%) gain tax $1,250 ($5,000  25%) Section 1231 gain tax $2,600 [($25,000 − $12,000)  20%)] Total $3,850 An alternative strategy is to sell the building in the current year and the land in the following year. The sale of the building would be treated as follows.

Unrecaptured Section 1250 (25%) gain tax $1,250 Section 1231 gain tax ($25,000  20%) $5,000 Total $6,250 And the land sold in the following year would be treated as follows: $(4,440) ($12,000  37%)

Section 1231 loss tax savings

The net result is a total tax for the two years of $1,810 ($6,250 − $4,440).

It is more advantageous to sell the assets in two different years. Selling the building in the current year generates a tax, but the lookback rule does not apply because no Section 1231 assets have been previously sold. Thus, the LTCG rates apply. Selling the land in the following year allows DeMarcus to use the 37% ordinary rate on the Section 1231 ordinary loss resulting in a larger savings. DeMarcus will save a total of $2,040 ($3,850 − $1,810) by selling the Section 1231 gain asset in the first year and selling the Section 1231 loss asset in the second year.

Time On Task: 15 minutes Communication Problem 21

1) Title: Communication Problem: Decision When to Sell Business Use Assets Difficulty: Medium Learning Objective 1: 14.1, 3, 4, 5 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 14.1, 3, 4, 5 Solution: Hello Sylvia, I have always enjoyed going to your salon for friendly and competent service. I am hoping to provide the same to you. You have asked for advice concerning the sale of some of your business assets to potentially purchase new assets and refresh your salon. Your goal is to utilize the shortterm capital loss of $10,000. Unfortunately, the sale will not help you in this regard. You need additional capital gains to offset the unused capital losses, but these sales would not generate capital gains. If you sell your assets, the tax results will be as follows:

Asset Chairs Furniture Basins

Cost $48,000 $25,000 $12,000

Depreciation Adjusted taken basis $30,000 $18,000 $15,000 $10,000 $ 3,000 $ 9,000

FMV $24,000 $ 8,000 $13,000

Gain/loss $ 6,000 ($ 2,000) $ 4,000

You would have a net gain from the sale of the business assets, but the character of the gain will not help offset a short-term capital loss. Because you took depreciation on the assets and received an ordinary deduction from the depreciation taken, the gain on the sale of the assets will be recharacterized from capital to ordinary to the extent of the depreciation taken.

Asset Chairs Furniture Basins

Gain/loss $ 6,000 ($2,000) $ 4,000

Character All ordinary because the gain is less than the depreciation taken Section 1231 $3,000 is ordinary because of the depreciation; $1,000 is Section 1231

Sales resulting in Section 1231 gains and losses must be netted against one another before the resulting character can be determined. You have a net Section 1231 loss of $1,000 ($1,000 gain from basins less $2,000 loss from furniture) which is treated as an ordinary loss.

Your new AGI would be determined as follows: Current AGI Ordinary income: Chairs Basins Total ordinary

$150,000 $ 6,000 3,000 9,000 22

Less: Section 1231 loss New AGI

( 1,000) $158,000

I am sorry that I did not have better news for you. Please let me know if I can be of further assistance.

Sincerely, Carnes & Youngberg, CPAs Time On Task: 20 minutes Ethics Problem 1) Title: Ethics Problem: Reliance on Workpapers of a Third Party Difficulty: Medium Learning Objective 1: 14.2, 3 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 14.2, 3 Solution: Circular 230 §10.24 provides that a practitioner may not knowingly, directly or indirectly, accept assistance from any person who is under disbarment or suspension from practice before the IRS if the assistance relates to a matter or matters constituting practice before the Internal Revenue Service. Under §10.22, a practitioner must exercise due diligence in preparing or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to Internal Revenue Service matters. You must try to find an accurate outside source to help verify the workpaper’s numbers such as the broker who sold the assets, or any original purchase invoices to determine the assets original cost.

Time On Task: 10 minutes Tax Compliance and Reporting Problem This problem is for 2024. The answer is reported on a 2023 Form 4797 because that was the most recent return available at the time of publication.

1) Title: Tax Compliance and Reporting Problem: Sale of Assets Difficulty: Medium Learning Objective 1: 14.1-5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 14.1-5 Solution:

23

[[COMP: See high-res PDF file: Carnes_I2025_Ch14_SM_TaxComplianceAndReporting_Form 4797 2023 Husky_page 1.pdf]]

24

25

[[COMP: See high-res PDF file: Carnes_I2025_Ch14_SM_TaxComplianceAndReporting_Form 4797 2023 Husky_page 2.pdf]]

26

Time On Task: 20 minutes Research Problem 27

1) Title: Research Problem: Potential Depreciation Recapture?

Difficulty: Medium Learning Objective 1: 14.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 14.5 Solution: IRC §1014(a)(1) states that the basis of property acquired by a decedent is equal to the asset’s fair market value as of the date of death. And IRC §1245(b)(2) states that recapture does not apply to a transfer at death. Therefore, the recapture potential is eliminated at death and does not carry over to the person who inherits the property (Siena). Siena’s basis in the assets inherited are the fair market value at death.

Time On Task: 10 minutes Excel Problem 1) Title: Excel Problem: Lookback Rule Difficulty: Hard Learning Objective 1: 14.3 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 14.3 Solution: a. Because Elonzo has a net Section 1231 gain in Year 20, he must look back for any unrecaptured net Section 1231 losses that were treated as ordinary in the previous five years.

Year 14 had a net Section 1231 gain of $6,500 that would have been treated as long-term capital gain.

Year 15 had a net Section 1231 loss of $2,000 that would have been treated as an ordinary loss.

Year 16 had a net Section 1231 loss of $4,500 that also would have been ordinary.

In Year 17, Elonzo had a net Section 1231 gain of $5,000. He would have treated the entire $5,000 Section 1231 gain as ordinary due to the unrecaptured loss of $2,000 from Year 15 and $3,000 in Year 16. There is $1,500 of the remaining unrecaptured losses from Year 16.

In Year 18, the net Section 1231 loss of $2,500 would have been ordinary and in Year 19, the net 1231 loss of $1,000 would have been ordinary.

28

In Year 20, Elonzo had a net Section 1231 gain of $12,000. There is remaining unrecaptured losses from Year 16, 18, and 19 of $1,500, $2,500, and $1,000, respectively.

Therefore, in Year 20, $5,000 would be ordinary income and the remaining $7,000 would be long-term capital gain. b. Because Elonzo has a net Section 1231 gain in Year 20, he must look back for any unrecaptured net Section 1231 losses that were treated as ordinary in the previous five years.

Years 14, 15, and 16 had a net Section 1231 loss of $6,500, $2,000, and $4,500 respectively, that would have been treated as an ordinary loss in each year.

In Year 17, Elonzo had a net Section 1231 gain of $5,000. He would have treated the entire $5,000 Section 1231 gain as ordinary due to the unrecaptured loss of $6,500 from Year 14. There is $1,500 of remaining unrecaptured losses from Year 14.

In Year 18, the net Section 1231 loss of $2,500 would have been ordinary and in Year 19, the net Section 1231 loss of $1,000 would have been ordinary.

In Year 20, Elonzo had a net Section 1231 gain of $12,000. There is remaining unrecaptured losses from Year 14, 15, and 16 of $1,500, $2,000, and $4,500, respectively. And there is remaining unrecaptured losses from Years 18 and 19 of $2,500 and $1,000, respectively. But the unrecaptured loss from Year 14 is expired. Therefore, total unrecaptured losses total $10,000.

Therefore, in Year 20, $10,000 would be ordinary income and the remaining $2,000 would be long-term capital gain.

Time On Task: 25 minutes

29

Excel Problem Input Area: Year

Gain (Loss)

Year 14

6,500

Year 15

(2,000)

Year 16

(4,500)

Year 17

5,000

Year 18

(2,500)

Year 19

(1,000)

Year 20

12,000

Calculation: Part a

Net Section 1231 Gain or Loss

Net Section 1231 Gains Before Lookback Rule

Year 14

6,500

6,500

-

-

-

6,500

Year 15

(2,000)

-

(2,000)

(2,000)

-

-

Year 16

(4,500)

-

(4,500)

(6,500)

-

-

Year 17

5,000

5,000

-

(1,500)

5,000

-

Year 18

(2,500)

-

(2,500)

(4,000)

-

-

Year 19

(1,000)

-

(1,000)

(5,000)

-

-

Year 20

12,000

12,000

-

-

5,000

7,000

Net Section 1231

Gains

Ordinary Loss

Ordinary Loss

Accumul ated Ordinary Loss

30

Accumulated Ordinary Loss After Lookback Rule

Expired Ordinary Loss

Expired Ordinary Loss

-

Ordinary Income

Ordinary Income from Lookback Rule

LTCG After Lookback Rule

LTCG

Yr 14

=VLOOKUP(A16,$ A$6:$B$12,2)

=IF(B16>0 ,B16,0)

=IF(B16<0 ,B16,0)

Yr 15

=VLOOKUP(A17,$ A$6:$B$12,2)

=IF(B17>0 ,B17,0)

=IF(B17<0 ,B17,0)

Yr 16

=VLOOKUP(A18,$ A$6:$B$12,2)

=IF(B18>0 ,B18,0)

=IF(B18<0 ,B18,0)

Yr 17

=VLOOKUP(A19,$ A$6:$B$12,2)

=IF(B19>0 ,B19,0)

=IF(B19<0 ,B19,0)

Yr 18

=VLOOKUP(A20,$ A$6:$B$12,2)

=IF(B20>0 ,B20,0)

=IF(B20<0 ,B20,0)

Yr 19

=VLOOKUP(A21,$ A$6:$B$12,2)

=IF(B21>0 ,B21,0)

=IF(B21<0 ,B21,0)

Yr 20

=VLOOKUP(A22,$ A$6:$B$12,2)

=IF(B22>0 ,B22,0)

=IF(B22<0 ,B22,0)

=D16 =IF(B17> =E16,0,E1 6+B17) =IF(B18> =E17,0,E1 7+B18) =IF(B19> =E18,0,E1 8+B19) =IF(B20> =E19,0,E1 9+B20) =IF(B21> =E20,0,E2 0+B21) =IF(B22> =E21,0,E2 1+B22)

=MIN(SUM(D12:D16)+S UM(C17:C21),0)

0

=IF(B16>G 16,B16G16,0)

=IF(D17<0,0,MIN(B 17,-E16+F17))

=IF(B17>G 17,B17G17,0)

=IF(D18<0,0,MIN(B 18,-E17+F18))

=IF(B18>G 18,B18G18,0)

=IF(D19<0,0,MIN(B 19,-E18+F19))

=IF(B19>G 19,B19G19,0)

=IF(D20<0,0,MIN(B 20,-E19+F20))

=IF(B20>G 20,B20G20,0)

=IF(D21<0,0,MIN(B 21,-E20+F21))

=IF(B21>G 21,B21G21,0)

=IF(D22<0,0,MIN(B 22,-E21+F22))

=IF(B22>G 22,B22G22,0)

[[COMP/CODERS: Use same headings as above.]]

Calculation Part b Net Section 1231 Gain or Loss

Net Section 1231 Gains Before Lookback Rule

Ordinary Loss

Accumulated Ordinary Loss After Lookback Rule

Expired Ordinary Loss

Ordinary Income from Lookback Rule

Year 14

(6,500)

-

(6,500)

(6,500)

-

Year 15

(2,000)

-

(2,000)

(8,500)

-

Year 16

(4,500)

-

(4,500)

(13,000)

-

Year 17

5,000

5,000

-

(8,000)

5,000

Year 18

(2,500)

-

(2,500)

(10,500)

-

Year 19

(1,000)

-

(1,000)

(11,500)

-

Year 20

12,000

12,000

-

-

CPA Exam Preparation: Task-Based Simulation 1.

31

(1,500)

10,000

Title: Task-Based Simulation: Calculating Gain/Loss and Character on Sale of Assets Difficulty: Medium Learning Objective 1: 14.4, 5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 14.4, 5 Solution Calculate the gain/loss and character from the inventory sale Calculate the gain/loss and character from the computer sale Calculate the gain/loss and character from the machinery sale Calculate the gain/loss and character from the equipment sale Calculate the gain/loss and character from the building sale Calculate the gain/loss and character from the truck sale Calculate the gain/loss and character from the land sale

Asset Inventory Computer Machinery Equipment Commercial Building Delivery Truck Unimproved Land Investment

Cost $ 27,000 2,500 34,000 32,000

Accumulate d Depreciatio n $ 0 2,500 27,000 28,000

−$2,000

Ordinary

$1,000

Ordinary

$3,000

Ordinary

−$1,000

Ordinary

$86,000 −$500

$51,000 25% gain, $35,000 Capital Ordinary

$4,000

Capital

Sale Price $25,000 $1,000 $10,000 $3,000

Adjusted Basis $27,000 $0 $7,000 $4,000

Realized and Recognized Gain/Loss ($2,000) $1,000 $3,000 ($1,000)

Character Ordinary 1245-Ordinary 1245-Ordinary 1231-Ordinary

350,000

51,000 $385,000

$299,000

$51,000 25% gain, $86,000 $35,000 1231 Capital

15,000

1,000

$13,500

$14,000

($500) Ordinary loss

16,000

0

$20,000

$16,000

$4,000 Short-Term Capital Gain

Inventory Inventory is an ordinary asset which results in ordinary gain or loss when sold.

Computer 32

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Tangible Personalty held long term (more than one year) and used in a trade or business is a Section 1231 asset. The computer is Section 1231 property and the gain is Section 1231 gain, except for potential recapture under Section 1245. Recapture recharacterizes Section 1231 capital gain to ordinary income. Section 1245 recapture is equal to the lesser of the recognized gain ($1,000) or accumulated depreciation ($2,500). Because the accumulated depreciation taken on the computer exceeds the recognized gain, all of the gain ($1,000) is recharacterized as ordinary income.

Machinery Machinery is also Section 1231 property because it was held for three years. The recognized gain is subject to Section 1245 recapture. Because the accumulated depreciation taken on the machinery ($27,000) exceeds the recognized gain ($3,000), all of the gain is recharacterized as ordinary income.

Equipment Equipment is Section 1231 property because it was owned for four years. Because it is sold at a loss, it is not subject to the recapture provision under Section 1245. The equipment loss is a 1231 loss and can be netted against other 1231 gains.

Commercial Building The building is a 1231 asset because its holding period is four years. Gains from the sale of buildings used in a business are subject to the Section 1250 recapture provisions. Under Section 1250, only the depreciation claimed in excess of straight-line depreciation is subject to recapture.

Because the commercial building was placed in service after 1986, straight line depreciation was taken, so none of the $86,000 gain is recaptured.

To the extent of straight-line depreciation claimed ($51,000), the recognized gain is taxed at a maximum rate of 25%.

The remaining gain of $35,000 ($86,000 − $51,000) is characterized as Section 1231 gain subject to a further netting process against any 1231 losses.

Delivery Truck The truck is tangible personalty used in a business but because it is not owned more than a year, it is an ordinary asset (rather than Section 1231). Therefore, the loss of $500 is an ordinary loss.

Investment Land The land is realty and depreciation is not allowed. Because the land was held for investment and not for business use, this land is a capital asset. The gain is a short-term capital gain. To be longterm, it would have to be owned more than one year.

Time On Task: 25 minutes

33

Chapter 15—Property Transactions: Nonrecognition of Gains and Losses End of Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Easy Learning Objective 1: 15.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.1 Solution: A related-party transaction is an agreement between two parties that have a preexisting business relationship or familial relationship. The term related party includes the following members of a family: spouse, children, grandchildren/other descendants, parents, grandparents/other ancestors, and brothers and sisters. Aunts, uncles, and cousins are not related parties. The related-party definition also does not include in-laws (although in-laws are eligible to be claimed as dependents). A business relationship can include ownership of more than 50% (directly or indirectly) of a corporation or partnership.

Time On Task: 2 min 2) Title: Discussion Question 2 Difficulty: Medium Learning Objective 1: 15.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.1 Solution: Yes, the selling price and fair market value may be the same or different. The disallowance rule still applies, even if a qualified appraisal that verifies they sold the asset for its actual value and a loss is realized.

Time On Task: 3 min 3) Title: Discussion Question 3 Difficulty: Medium Learning Objective 1: 15.1 & 5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.1 & 5 Solution: 15-1

No, the right of offset is not applicable if the original sale was from the sale of personal use property, because realized losses from the sale or disposition of personal use property are never recognized. The disallowed loss from a related-party sale creates a right of offset, which taxpayers can use to reduce a gain upon the ultimate sale of the property to an unrelated taxpayer. The right of offset cannot create a loss, nor can it make a loss greater.

Time On Task: 3 min 4) Title: Discussion Question 4 Difficulty: Easy Learning Objective 1: 15.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.2 Solution: A wash sale is a transaction in which a taxpayer sells a security at a loss in order to deduct a capital loss on the tax return, but then repurchases it (or a substantially identical security) within 30 days before or after the date of sale. If the wash sale rules apply, a realized loss is not recognized.

Time On Task: 2 min 5) Title: Discussion Question 5 Difficulty: Medium Learning Objective 1: 15.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.2 Solution: No, the wash sale rules do not apply to taxpayers engaged in the business of buying and selling stock because the stock is considered inventory in the hands of a broker who regularly trades financial securities.

Time On Task: 2 min 6) Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 15.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.2 Solution:

15-2

In a wash sale, the holding period of the newly acquired stock begins on the date that the original shares were purchased and then sold at a loss.

Time On Task: 2 min 7) Title: Discussion Question 7 Difficulty: Medium Learning Objective 1: 15.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.2 Solution: a. Because Bruce sold his shares on February 15 and had purchased additional shares on March 9, this falls within the 30-day window and would be considered a wash sale. b. Because Bruce sold his shares on March 31 and had purchased 50 additional shares on March 9, which falls within the 30-day window, 50 of the 150 shares would be considered a wash sale. Wash sale time periods are 30 days before or after the date of sale. However, the 100 shares purchased on January 10 are not considered a wash sale because they were not purchased 30 days before the sale date of March 31. c. Because Bruce sold his shares on April 10 and had purchased additional shares on March 9, the purchase falls outside of the 30-day window and would not qualify as a wash sale.

Time On Task: 5 min 8) Title: Discussion Question 8 Difficulty: Easy Learning Objective 1: 15.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.3 Solution: The rules under §1031 are mandatory. If the amount realized is less than the adjusted basis of the assets given up and the property is of a like-kind, then a loss is realized but not recognized.

Time On Task: 1 minute 9) Title: Discussion Question 9 Difficulty: Easy Learning Objective 1: 15.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting 15-3

Standard 3: Bloom's || Knowledge Section Reference 1: 15.4 Solution: An involuntary conversion is the result of the destruction (complete or partial), theft, seizure, casualty (an unexpected, unavoidable outside influence like a storm, fire, shipwreck, or condemnation), or sale or exchange under threat of condemnation of the taxpayer’s property. A condemnation is a taking of property by the government under its right of eminent domain, which is the power to take property for public use.

Time On Task: 2 minutes 10) Title: Discussion Question 10 Difficulty: Medium Learning Objective 1: 15.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.4 Solution: Generally, any realized gain is deferred to the extent the taxpayer reinvests the amount realized from the insurance proceeds or condemnation award in replacement property. If the amount reinvested in replacement property is less than the amount realized, the realized gain is recognized to the extent of this deficit. This may occur in a different year than the conversion.

The qualified replacement period ends two years from the end of the tax year in which the taxpayer realizes the gain from the conversion.

Time On Task: 3 minutes 11) Title: Discussion Question 11 Difficulty: Medium Learning Objective 1: 15.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.4 Solution: December 31, Year 12. In an involuntary conversion, the taxpayer must purchase replacement property within two years from the end of the year in which the gain was realized. Gabby received the insurance check on January 17, Year 10 which is when her gain is realized, so she has until December 31, Year 12 to replace the damaged property. The important date is the date where the gain was realized not the date in which the involuntary conversion took place.

Time On Task: 2 minutes 12) Title: Discussion Question 12 Difficulty: Medium 15-4

Learning Objective 1: 15.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.4 Solution: Gabby received the insurance check on January 17, Year 10 which is when her gain is realized.

Because Gabby’s business property was condemned, Gabby has three years from the end of the year in which the gain was realized. So, Gabby has until December 31, Year 13 to replace the property. The taxpayer can request an extension of this period from the IRS, but only for one additional year.

Time On Task: 2 minutes 13) Title: Discussion Question 13 Difficulty: Easy Learning Objective 1: 15.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.4 Solution: The replacement property must be similar or related in the service or use to the destroyed property. Ricardo’s Chicken Shack was a restaurant, so replacing it with another restaurant would qualify. It does not matter what type of food is being sold. The end use of the replacement property must be similar to the use of the converted property. End use can be defined as the application or function for which something is designed or for which it is ultimately used.

Time On Task: 2 minutes 14) Title: Discussion Question 14 Difficulty: Easy Learning Objective 1: 15.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.6 Solution: A principal residence can be a house, trailer home, motor home, or a houseboat. To be a residence, the structure must have sleeping, cooking, and bathroom facilities.

Time On Task: 1 minute 15) Title: Discussion Question 15 Difficulty: Easy Learning Objective 1: 15.6 15-5

Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.6 Solution: No. A taxpayer can have more than one residence, but only one residence can qualify as the principal residence Time On Task: 1 minute 16) Title: Discussion Question 16 Difficulty: Easy Learning Objective 1: 15.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.6 Solution: These factors determine whether a property qualifies as a principal residence: • Where does the taxpayer spend most of their time?

• What address is listed on the taxpayer’s driver’s license and tax return?

• Where does the taxpayer register to vote?

Time On Task: 2 minutes 17) Title: Discussion Question 17 Difficulty: Medium Learning Objective 1: 15.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.6 Solution: In order to qualify for the exclusion of gain treatment, the taxpayer must have (1) owned and (2) used the residence for at least two years during a five-year period ending on the date of the sale.

The two-year period does not need to be continuous, and the ownership and use does not need to be at the same time. (3) The frequency test also requires that the taxpayer has not excluded gain from the sale of another principal residence during the two-year time period ending on the date of the sale.

Time On Task: 2 minutes 18) Title: Discussion Question 18 Difficulty: Medium Learning Objective 1: 15.6 Standard 1: AACSB || Knowledge 15-6

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.6 Solution: No, a taxpayer may temporarily rent out their principal residence for a short period of time, as long as the two-year requirement for the ownership and use tests is satisfied.

Time On Task: 2 minutes 19) Title: Discussion Question 19 Difficulty: Hard Learning Objective 1: 15.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.6 Solution: Yes, Javier is eligible because he has owned and used the home as his principal residence for at least two of the five years preceding the sale. Temporary rental does not prevent a taxpayer from using the gain exclusion.

Time On Task: 3 minutes Multiple Choice Questions 1) Answer: b, c Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 15.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.1 Solution: The correct answers are: • A shareholder who owns 60% of a corporation’s stock, and • Brother and sister.

Both meet the definition of a related party. The two cousins do not meet the family membership definition for related parties. Family members include brothers, sisters, spouses, parents, grandparents and lineal descendants (children and grandchildren) of the taxpayer. In-laws are also not considered to be related parties for this purpose (although in-laws are eligible to be claimed as dependents).

Time On Task: 2 minutes 2) Answer: d 15-7

Title: Multiple Choice Question 2 Difficulty: Medium Learning Objective 1: 15.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.1 Solution: The correct answer is $7,000.

The loss on sale to Tang of $5,000 (Amount realized $18,000 – Adjusted basis $23,000) is not recognized due to related party rules. However, it does create a right of offset for $5,000. Thus, when Tang subsequently sells the stock, there is a realized gain of $12,000 (Amount realized $30,000 – Adjusted basis $18,000). The $5,000 right of offset reduces Tang’s recognized gain from $12,000 to $7,000.

Time On Task: 4 minutes 3) Answer: c Title: Multiple Choice Question 3 Difficulty: Medium Learning Objective 1: 15.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.2 Solution: The correct answer is Gain/Loss $0 and Basis $11,000.

This is a wash sale so the loss of $8,000 (Amount realized $2,000 – Adjusted basis $10,000) is disallowed. Stock was repurchased within 30 days of being sold. Deferred loss of $8,000 is added to basis of new stock.

Time On Task: 4 minutes 4) Answer: a Title: Multiple Choice Question 4 Difficulty: Easy Learning Objective 1: 15.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.3 Solution: The correct answer is An apartment building for commercial store front property.

Only real property for real property qualifies for like-kind exchange treatment. Only this option satisfies this definition. Both the taxpayer’s personal residence and an investment rental house

15-8

are realty, but the assets must be used by the taxpayer for investment or business purposes.

Because the residence was personal use property, it does not qualify as a like-kind exchange.

Time On Task: 2 minutes 5) Answer: b Title: Multiple Choice Question 5 Difficulty: Easy Learning Objective 1: 15.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.3 Solution: The correct answer is Exchange of business office building for investment land.

Realty for realty qualifies (land for building) used for investment and business purpose, but not personal use property. Option “Exchange of business office building for investment land” satisfies this definition.

Time On Task: 2 minutes 6) Answer: b Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 15.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.3 Solution: The correct answer is $40,000.

The realized gain on the transaction is $60,000 [Amount realized ($120,000 + $40,000 – Adjusted basis $100,000). However, the recognized gain is the lower of the amount realized ($60,000) or the boot received $40,000. Thus, the recognized gain is the boot received, $40,000 (cash).

Time On Task: 3 minutes 7) Answer: a Title: Multiple Choice Question 7 Difficulty: Hard Learning Objective 1: 15.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.3 15-9

Solution: The correct answer is $80,000.

Basis is value of new property ($150,000) reduced by any deferred gain ($70,000, because $50,000 of the overall gain of $120,000 is recognized). Calculated as follows: Amount realized $200,000 ($150,000 + $50,000) Less: Adjusted basis ( 80,000) Realized gain $120,000 Recognized gain = lower of: Realized gain $120,000 Boot received $ 50,000 FMV of new equipment received Less: Deferred gain Basis of new equipment Time On Task: 5 minutes

$150,000 ( 70,000) $ 80,000

8) Answer: c Title: Multiple Choice Question 8 Difficulty: Medium Learning Objective 1: 15.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.4 Solution: The correct answer is December 31, Year 12 Replacement period ends two years from the end of the tax year in which the taxpayer realizes the gain from the conversion.

Time On Task: 2 minutes 9) Answer: b Title: Multiple Choice Question 9 Difficulty: Easy Learning Objective 1: 15.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.6 Solution: The correct answer is Moving closer to a vacation home The other choices are all valid exceptions. Moving closer to a vacation home would not qualify.

Time On Task: 2 minutes 15-10

10) Answer: a Title: Multiple Choice Question 10 Difficulty: Medium Learning Objective 1: 15.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.6 Solution: The correct answer is $0.

Potter meets requirements for exclusion of gain of up to $250,000 for sale of principal residence.

He has met the use and ownership tests. The $250,000 exclusion fully eliminates the Realized Gain of $135,000 ($350,000 − $15,000 − $200,000).

Time on Task: 3 minutes 11) Answer: c Title: Multiple Choice Question 11 Difficulty: Easy Learning Objective 1: 15.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 15.6 Solution: The correct answer is until February 22, Year 12 Mariah must own and use the principal residence for at least two years.

Time On Task: 2 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 15.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.1 Solution: Harriet will recognize a loss of $3,000 (Amount realized $15,000 – Adjusted basis $18,000). The loss is recognized because a cousin is not considered a related party. Ethyl will recognize a gain of $10,000 (Amount realized $25,000 – Adjusted basis $15,000). Because the loss on the original sale was recognized, no right of offset was created, and Ethyl will recognize her entire gain.

15-11

Time On Task: 5 minutes 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 15.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.1 Solution: Harriet will realize a loss of $3,000 (Amount realized $15,000 – Adjusted basis $18,000). If Harriet sold the 500 shares to her brother, this would be considered a related party sale, and her $3,000 loss would be disallowed. This creates a $3,000 right of offset that her brother can use to offset his $10,000 gain (Amount realized $25,000 – Adjusted basis $15,000), resulting in a net gain of $7,000.

Time On Task: 5 minutes 3) Title: Brief Exercise 3 Difficulty: Easy Learning Objective 1: 15.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.2 Solution: Lakshmi will have a realized and recognized gain of $600 (Amount realized $6,000 – Adjusted basis $5,400). The wash sale rules do not apply to gains. The basis in the 100 shares purchased on January 8 is the cost basis of $1,700.

Time On Task: 2 minutes 4) Title: Brief Exercise 4 Difficulty: Hard Learning Objective 1: 15.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.2 Solution: Lakshmi will have a realized loss of $900 (Amount realized $4,500 – Adjusted basis $5,400).

This transaction is a wash sale because Lakshmi sold her 300 shares at a loss, and then within 30 days, repurchased 100 identical shares. The wash sale rules apply if the purchase of the identical shares is within 30 days before or after the date of sale. Because Lakshmi repurchased only 100 shares of the 300 shares that were previously sold at a loss, only 33.33% (100/300) of the $900 15-12

realized loss is disallowed (33.33%  $900 = $300). Her recognized loss is $600. Realized losses that are not recognized are added to the basis of the newly acquired shares. Lakshmi’s basis in the new shares purchased on January 8 is thus $2,000, calculated as follows: Cost of new stock Plus: Deferred loss Basis in new stock Time On Task: 6 minutes

$1,700 300 $2,000

5) Title: Brief Exercise 5 Difficulty: Easy Learning Objective 1: 15.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.3 Solution: Tabby has a realized and recognized gain of $600 (Amount realized $4,800 (inventory $4,000 + cash $800) – Adjusted basis $4,200). Inventory does not qualify for like-kind exchange treatment so, therefore, all the gain is recognized.

Time On Task: 2 minutes 6) Title: Brief Exercise 6 Difficulty: Medium Learning Objective 1: 15.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.3 Solution: a. If Tabby exchanged machinery for machinery with Persian Company, it would not qualify for like-kind exchange treatment. Only real property for real property qualifies for like-kind exchange treatment. b. If land were exchanged, then this transaction would qualify for like-kind exchange treatment. However, because cash (boot) was received, Tabby would have a partial gain to recognize: Recognized gain or loss is the lower of: Realized gain or loss, or Fair market value of boot received

$600 (4,000 + 800 − 4,200) $800

Therefore, Tabby Company has a $600 recognized gain.

15-13

Time On Task: 6 minutes 7) Title: Brief Exercise 7 Difficulty: Medium Learning Objective 1: 15.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.4 Solution: Annika has a realized loss of $50,000 (Amount realized $400,000 – Adjusted basis $450,000).

While condemnations are an involuntary conversion, the involuntary conversion rules do not apply to losses. Losses on personal use assets can be deducted only if they are a casualty loss.

She cannot deduct this loss on her return as an involuntary conversion because it is considered a loss on a personal use asset and not a casualty loss.

Time On Task: 3 minutes 8) Title: Brief Exercise 8 Difficulty: Medium Learning Objective 1: 15.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.4 Solution: Annika has a realized gain of $85,000 (Amount realized $535,000 – Adjusted basis $450,000). A condemnation qualifies as an involuntary conversion. She replaced the property within two years of the end of the year in which the gain is realized and the replacement property has a similar use to the initial property.

The recognized gain is the lower of: a. The realized gain, or $ 85,000 b. The excess of the proceeds from the conversion over the cost of the replacement property: Amount realized from conversion Less: Cost of replacement property Excess

$535,000 $480,000 $ 55,000

Annika’s recognized gain is $55,000. The deferred gain is $30,000 (Realized gain $85,000 – Recognized gain $55,000).

Time On Task: 7 minutes

15-14

9) Title: Brief Exercise 9 Difficulty: Easy Learning Objective 1: 15.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.5 Solution: Chevy has a realized loss of $13,000 (Amount realized $45,000 – Adjusted basis $58,000).

Chevy’s recognized loss is zero. He cannot deduct a loss on the sale of a personal use asset.

Time On Task: 2 minutes 10) Title: Brief Exercise 10 Difficulty: Medium Learning Objective 1: 15.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.6 Solution: Iker and Roslyn have a realized gain of $128,000, calculated as follows: Amount realized Less: Adjusted basis Realized gain

$520,000 ( 392,000) ($345,000 + $25,000 + $22,000) $128,000

The cost of planting trees is not considered a capital improvement and not included in the basis of the house.

Iker and Roslyn have a recognized gain of $0: Realized gain Less: Exclusion Recognized gain

$128,000 (128,000) $ 0

Because the couple owned and used the house for at least two of the last five years, they may exclude up to $500,000 from the sale of their principal residence.

Time On Task: 6 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium 15-15

Learning Objective 1: 15.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.1 Solution: a.

Amount realized $39,000 Less: Adjusted basis ( 52,000) Realized loss ($13,000) Because Stan and Evan are brothers, they are considered related parties under §267.

Realized losses from the sale or exchange of property between certain related parties are disallowed and not recognized. Evan’s recognized loss is $0. Stan’s basis in the land purchased is his purchase price of $39,000. b. The loss of $13,000 from the sale from Evan to Stan is disallowed and not recognized

by Evan. This creates a right of offset of $13,000 that Stan can use to reduce any realized gain when he sells the property to zero. When Stan sells the land, he has a realized gain of $26,000: Amount realized Less: Adjusted basis Realized gain

$65,000 (39,000) $26,000

Stan’s gain is reduced by the right of offset to $13,000 ($26,000 − $13,000; see calculation in part a). Therefore, Stan’s recognized gain is $13,000. c. The loss of $13,000 from the sale from Evan to Stan is disallowed and not recognized

by Evan. This creates a right of offset of $13,000 that Stan can use to reduce any realized gain when he sells to property to zero. When Stan sells the land, he has a realized gain of $6,000: Amount realized Less: Adjusted basis Realized gain

$45,000 (39,000) $ 6,000

Stan’s gain is reduced by the right of offset, but only to the extent of Stan’s realized gain of $6,000. The right of offset cannot create or increase a loss. Stan’s recognized gain is $0. The remaining right of offset of $7,000 ($13,000 − $6,000) is gone forever. d. The loss of $13,000 from the sale from Evan to Stan is disallowed and not recognized

by Evan. This creates a right of offset of $13,000 that Stan can use to reduce any realized gain when he sells to property to zero. When Stan sells the land, he has a realized loss of $4,000: Amount realized

$35,000 15-16

Less: Adjusted basis (39,000) Realized loss ($4,000) The right of offset cannot create or increase a loss so none of it can be used. Stan’s recognized loss is $4,000. The $13,000 right of offset is gone forever.

Time On Task: 10 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 15.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.2 Solution: a. Joy has a realized loss of $3,000: Amount realized $ 3,000 Less: Adjusted basis ( 6,000) Realized loss ($3,000) Joy’s recognized capital loss is $0. This transaction is a wash sale because Joy sold her 600 shares at a loss and then within 30 days, repurchased identical shares. b. Realized losses that are not recognized because of a wash sale are added to the basis of the newly acquired shares. Joy’s basis in the new shares is $6,500: Purchase price Disallowed wash sale loss Basis in new shares

$3,500 3,000 $6,500

c. Joy’s holding period for the new stock includes the holding period of the stock sold, so it begins on March 13, Year 12.

Time On Task: 6 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 15.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.2 Solution:

15-17

Aran’s basis in the shares sold is $7,500 because he sold only 50% (100 shares/200 shares) of his shares ($15,000 basis  50% = $7,500). Aran has a realized loss of $3,500: Amount realized $ 4,000 Less: Adjusted basis ( 7,500) Realized loss ($3,500) This transaction is a wash sale because Aran sold his 100 shares and then within 30 days, repurchased 60 identical shares. Because Aran repurchased only 60 shares of the 100 shares that were previously sold at a loss, only 60% (60/100) of the $3,500 realized loss is disallowed (60%  $3,500 = $2,100). Aran’s recognized loss is $1,400. Realized losses that are not recognized are added to the basis of the newly acquired shares. Aran’s basis in the new shares is $4,600: Cost of new stock Plus: Deferred loss Basis in new stock Time On Task: 6 minutes

$2,500 2,100 $4,600

4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 15.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.2 Solution: Robert has a realized loss of $1,500: Amount realized $ 8,500 Less: Adjusted basis (10,000) Realized loss ($1,500) Robert’s allowable capital loss is $375. This transaction is a wash sale because Robert sold his 100 shares and then within 30 days, repurchased 75 identical shares. The wash sale rules apply if the purchase of the identical shares is within 30 days before or after the date of sale. Because Robert repurchased only 75 shares of the 100 shares that were previously sold at a loss, only 75% (75/100) of the $1,500 realized loss is disallowed (75%  $1,500 = $1,125). Robert’s recognized loss is $375. Realized losses that are not recognized are added to the basis of the newly acquired shares. Robert’s basis in the new shares is $8,125: Cost of new stock Plus: Deferred loss Basis in new stock Time On Task: 6 minutes

$7,000 1,125 $8,125

15-18

5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 15.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.2 Solution: Greg’s adjusted basis in the 350 shares sold is $3,500 (350  $10 per share). (Total Cost ($4,000)/Total Shares (300 + 100) = $10 Per Share). Greg has a realized and recognized gain of $300 (Amount realized $3,800 – Adjusted basis $3,500). The wash sale rules do not apply to gains. His remaining 50 shares have a basis of $500.

Time On Task: 5 minutes 6) Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 15.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.3 Solution: a. Realized gain or loss of $250,000 (Amount realized of $800,000 – Adjusted basis in disposed asset $550,000).

Fabian’s exchange qualifies for deferral of gain recognition treatment under the like-kind exchanges rules because both assets are realty, and both are used for investment or business purposes. b. Recognized gain or loss is the lower of Realized gain or loss, or Fair market value of boot received

$250,000 $0

Therefore, Fabian has $0 recognized gain. c. His basis in the apartment building received is a substituted basis of $550,000. See the calculation below: FMV of property received Less: Deferred gain Basis

$800,000 ( 250,000) $550,000

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d. His holding period in the apartment building received is six years because it includes the holding period of the transferred lot.

Time On Task: 10 minutes 7) Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 15.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.3 Solution: a. Realized gain or loss is still $250,000 (Amount realized of $750,000 + $50,000 − Adjusted basis in disposed asset $550,000). This exchange still qualifies for like-kind exchange treatment. b. Recognized gain or loss is the lower of: Realized gain or loss, or Fair market value of boot received

$250,000 $ 50,000

Deferred gain or loss ($200,000) = Realized gain or loss ($250,000) less recognized gain or loss ($50,000) c. Fabian’s basis in the property received is: Adjusted basis of land given up Plus: Gain recognized Less: Boot received Basis in apartment received

$550,000 50,000 ( 50,000) $550,000

or FMV of property received Less: Deferred gain Basis in apartment received

$750,000 (200,000) $550,000

Fabian’s basis in the boot received is its fair market value of $50,000. d. His holding period in the apartment building received is six years because it includes the holding period of the transferred lot.

Time On Task: 10 minutes 8) Title: Application Problem 8 15-20

Difficulty: Hard Learning Objective 1: 15.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.3 Solution: a. Realized gain or loss equals: FMV of apartment received Plus: Cash received Plus: Debt relief Amount realized Less: Adjusted basis of land given up Realized gain

$ 425,000 50,000 325,000 $ 800,000 ( 550,000) $ 250,000

Fabian has boot received of $375,000: $50,000 for the cash and $325,000 for the debt relief. b. Recognized gain or loss of $250,000 is the lower of: Realized gain or loss, or FMV of boot received

$250,000 $375,000

Deferred gain or loss ($0) = Realized gain or loss ($250,000) less recognized gain or loss ($250,000) c. Fabian’s basis in the property received: Adjusted basis of land given up Plus: Gain recognized Less: Boot received Basis in apartment received

$550,000 250,000 ( 375,000)* $425,000

*Debt relief also reduces the basis in the property received. Because debt relief is included as boot received for like-kind exchanges, the debt relief is not shown separately.

Fabian’s basis in the apartment building can also be computed as: Fair market value of property received Less: Deferred gain Basis in apartment received

$425,000 (0) $425,000

Fabian has a fair market value basis of $50,000 in the cash since it is boot. The remaining boot of $325,000 is for the debt relief.

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d. His holding period in the apartment building received is six years because it includes the holding period of the transferred lot.

Time On Task: 12 minutes 9) Title: Application Problem 9 Difficulty: Hard Learning Objective 1: 15.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.3 Solution: a. Realized gain or loss equals: FMV of apartment received Plus: Cash received Plus: Debt relief Less: Mortgage assumed by Fabian Amount realized Less: Adjusted basis of land given up Realized gain

$625,000 50,000 325,000 ( 200,000) $800,000 ( 550,000) $250,000

Boot Received Computation: Debt assumed by other party Less: Debt assumed by Fabian Net debt relief Plus: Cash received Total boot received b.

$ 325,000 ( 200,000) $ 125,000 50,000 $ 175,000

Recognized gain or loss is $175,000, the lower of: Realized gain, or FMV of boot received

$250,000 $175,000

Deferred gain or loss ($75,000) = Realized gain or loss ($250,000) less recognized gain or loss ($175,000) c.

Fabian’s basis in the property received: Adjusted basis of land given up Plus: Gain recognized Less: Boot received Basis in apartment received

15-22

$550,000 175,000 (175,000) $550,000

or FMV of property received Less: Deferred gain Basis in apartment received

$625,000 (75,000) $550,000

His deferred gain is $75,000 ($250,000 realized gain less $175,000 recognized gain).

Note that the fair market value of the apartment building received is $625,000 and its basis is $550,000. If the apartment building received was sold at its current fair market value, the deferred gain of $75,000 would be recognized at that time ($625,000 − $550,000). d. His holding period in the apartment building received is six years because it includes the holding period of the transferred lot.

Time on Task: 12 minutes 10) Title: Application Problem 10 Difficulty: Hard Learning Objective 1: 15.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.3 Solution: a. Realized gain or loss equals: FMV of apartment received Plus: Cash received Plus: Debt relief Less: Mortgage assumed by Fabian Amount realized Less: Adjusted basis of land given up Realized gain Debt assumed by other party Less: Debt assumed by Fabian Net debt relief

$775,000 50,000 325,000 (350,000) $800,000 (550,000) $250,000 $ 325,000 (350,000) ($ 25,000)

Boot Received Computation: The debt assumed by Fabian is greater than the debt he was relieved of by $25,000. This negative debt relief cannot offset the $50,000 of cash (boot) received. So, the net boot received is $50,000. b. Recognized gain or loss is $50,000, the lower of: 15-23

Realized gain, or FMV of boot received (cash)

$250,000 $ 50,000

Deferred gain or loss ($200,000) = Realized gain or loss ($250,000) less recognized gain or loss ($50,000) c. Fabian’s basis in the property received: Adjusted basis of land given up Plus: Gain recognized Less: Boot received (cash) Plus: Net boot given (debt) Basis in apartment received

$550,000 50,000 (50,000) 25,000 $575,000

or FMV of property received Less: Deferred gain Basis in apartment received

$775,000 (200,000) $575,000

Fabian’s basis in the boot received is its fair market value of $50,000. d. His holding period in the apartment building received is six years because it includes the holding period of the transferred lot.

Time On Task: 12 minutes 11) Title: Application Problem 11 Difficulty: Medium Learning Objective 1: 15.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.3 Solution: a. Realized gain or loss equals FMV of equipment received $2,500 Plus: Cash received 700 Amount realized $3,200 Less: Adjusted basis of equipment given up (4,000) Realized loss ($ 800)

15-24

b. Recognized loss equals $800. This exchange does not qualify for like-kind exchange treatment. Equipment is personalty, not realty. See coverage of recognized exchanges in Chapter 2, LO6, Introduction to Property Transactions. c. Emily’s basis in the new equipment is its fair market value of $2,500. d. Emily’s holding period for the new equipment begins on the date of exchange, April 15, Year 4.

Time On Task: 8 minutes 12) Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 15.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.4 Solution: a. Ally has a realized gain of $172,000: Amount realized Less: Adjusted basis Realized gain

$750,000 (578,000) $172,000

b. Ally has a recognized gain of $0. She can elect to defer the entire gain because she invested her entire proceeds of $750,000 in the new restaurant which cost $800,000. She has a deferred gain of $172,000. c. Ally has a basis in the new restaurant of $628,000: Cost of replacement property Less: Deferred gain Basis in new restaurant Time On Task: 6 minutes

$800,000 (172,000) $628,000

13) Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 15.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.4 Solution: a. Ally has a realized gain of $172,000: 15-25

Amount realized Less: Adjusted basis Realized gain

$750,000 (578,000) $172,000

b. Ally can elect to limit her recognized gain to $120,000: Amount realized Less: Cost of replacement property Recognized gain

$750,000 (630,000) $120,000

The recognized gain is limited to the lower of the realized gain or the proceeds not reinvested in qualifying property. Ally has a deferred gain of $52,000 ($172,000 Realized gain − $120,000 Recognized gain). c. Ally has a basis in the new restaurant of $578,000: Cost Less: Deferred gain Basis in new restaurant Time On Task: 6 minutes

$630,000 (52,000) $578,000

14) Title: Application Problem 14 Difficulty: Medium Learning Objective 1: 15.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.4 Solution: Ally has a realized loss of $78,000: Amount realized Less: Adjusted basis Realized loss

$ 500,000 ( 578,000) ($ 78,000)

Her recognized loss is also $78,000. If an involuntary conversion results in a loss, the involuntary conversion rules do not apply. The loss is deductible subject to any limitations provided by the casualty loss rules.

Time On Task: 4 minutes 15) Title: Application Problem 15 Difficulty: Easy Learning Objective 1: 15.5 15-26

Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.5 Solution: Barak and Sandy’s realized loss is $65,000: Amount realized Less: Adjusted basis Realized loss

$ 325,000 ( 390,000) ($ 65,000)

Barak and Sandy’s recognized loss is $0. Because the home is a personal use asset, no loss can be recognized.

Time On Task: 2 minutes 16) Title: Application Problem 16 Difficulty: Easy Learning Objective 1: 15.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.5 Solution: Daniel’s realized loss is $2,000: Amount realized Less: Adjusted basis Realized loss

$10,000 ( 12,000) ($ 2,000)

Daniel’s recognized loss is $0. Because the car was a personal use asset, no loss can be recognized.

Time On Task: 2 minutes 17) Title: Application Problem 17 Difficulty: Medium Learning Objective 1: 15.5 & 6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.5 & 6 Solution: Gary and Roberta have an adjusted basis in the property of $725,000: Cost

$600,000 15-27

Capital improvements Adjusted basis of property

125,000 $725,000

Their realized loss is $75,000 (Amount realized $650,000 − Adjusted basis $725,000). The loss cannot be recognized because their principal residence is a personal use asset.

Time On Task: 3 minutes 18) Title: Application Problem 18 Difficulty: Medium Learning Objective 1: 15.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.6 Solution: Diego does meet the ownership test because he owned the Miami property for two of the five years prior to the sale. The Miami home was sold on August 31, Year 20 so the five-year window runs from September 1, Year 15 through the date of sale. During this five-year window, Diego used the Miami house as his principal residence for only nine months from September 1, Year 15 through June 1, Year 16. Diego fails the use test and does not qualify for the exclusion of gain.

Time On Task: 4 minutes 19) Title: Application Problem 19 Difficulty: Medium Learning Objective 1: 15.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.6 Solution: a. Chuck and Mary will realize a gain of $420,000: Amount realized Less: Adjusted basis Realized gain

$500,000 (80,000) $420,000

Their recognized gain will be $0. Chuck and Mary can exclude up to $500,000 of the gain because the home is their principal residence, and they meet the ownership and use tests. b. Chuck and Mary will realize a gain of $520,000: Amount realized

$600,000 15-28

Less: Adjusted basis Realized gain

(80,000) $520,000

Their recognized gain will be $20,000: Realized gain Less: Gain exclusion Recognized gain Time On Task: 6 minutes

$520,000 (500,000) $ 20,000

20) Title: Application Problem 20 Difficulty: Medium Learning Objective 1: 15.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.6 Solution: Faisal does qualify for the exclusion because the distance between his old residence (Geneva) and the old job location (Chicago) is 45 miles and the distance between the old residence (Geneva) and the new job location (Milwaukee) is 110 miles. The difference of 65 miles meets the exception under change of employment. The exception for change in employment is assumed to be met if the individual's new place of employment is at least 50 miles farther from the residence sold than the distance from the old place of employment to the residence sold.

Time On Task: 3 minutes 21) Title: Application Problem 21 Difficulty: Hard Learning Objective 1: 15.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.6 Solution: Butch and Genny’s realized gain on the sale of the second Atlanta home is $215,000 (Amount realized $425,000 – Adjusted basis $210,000). The sale of the second home does not qualify for the full gain exclusion because they used and owned the home for only 9 months. However, due to the sale resulting from a change in employment, Butch and Genny will qualify for partial exclusion treatment.

Realized gain Less: Maximum gain exclusion: (9 months/24 months  $500,000) Recognized gain

$215,000 (187,500) $ 27,500 15-29

Time On Task: 5 minutes 22) Title: Application Problem 22 Difficulty: Hard Learning Objective 1: 15.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.6 Solution: No gain can be excluded. Pamela sold a home and used the gain exclusion in April Year 8.

Because the Tacoma home was sold in March Year 10, two years has not elapsed between the sale dates, so the frequency test is failed. Also, Pamela has not owned and used the Tacoma home for two years since it was purchased. Peter has lived in the Tacoma home from June Year 9 to February Year 10, which is only nine months, so he does not qualify for any exclusion either.

Time On Task: 4 minutes 23) Title: Application Problem 23 Difficulty: Medium Learning Objective 1: 15.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.6 Solution: Francine’s adjusted basis in the property is $94,000: Cost Capital improvements Adjusted basis

$69,000 25,000 $94,000

Francine has a realized gain of $506,000 Amount realized Less: Adjusted basis Realized gain

$600,000 (94,000) $506,000

Fred and Francine qualify for the $500,000 exclusion because they met the ownership and use tests for the five-year period before June Year 10. Francine sold the home within two years of Fred’s death, so she may use the entire $500,000 exclusion. Francine’s recognized gain will be $6,000: Realized gain

$506,000 15-30

Less: Gain exclusion (500,000) Recognized gain $ 6,000 Time on Task: 6 minutes 24) Title: Application Problem 24 Difficulty: Hard Learning Objective 1: 15.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 15.6 Solution: Jose’s adjusted basis in his property is $207,000: Cost Less: Accumulated Depreciation Adjusted basis

$250,000 (43,000) $207,000

Jose has a realized gain of $268,000: Amount realized $475,000 Less: Adjusted basis (207,000) Realized gain $268,000 Jose qualifies to exclude up to $250,000 of his realized gain. However, because Jose has taken depreciation expense of $43,000, he must recognize gain of $43,000. The remaining gain of $225,000 ($268,000 − $43,000) can be excluded from income.

Time On Task: 6 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Hard Learning Objective 1: 15.1 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 15.1 Solution: If Benjamin sells the asset to his dad, he has a realized loss of $4,000 (Amount realized $11,000 – Adjusted basis $15,000). Benjamin and his dad are defined as related parties for purposes of the related party loss rule. Realized losses from the sale or exchange of property between certain related parties are disallowed and not recognized. Therefore, Benjamin’s recognized loss is $0.

He would have a net cash flow of: 15-31

Tax savings from loss 0 Net cash flow $11,000 If Benjamin sells the equipment to his best friend, he has a realized loss of $5,000 (Amount realized $10,000 – Adjusted basis $15,000). Benjamin and his best friend are not related, so Benjamin can deduct the loss on his tax return. His recognized loss is $5,000. Benjamin’s tax savings from the loss will be the amount of the deduction multiplied by his marginal tax rate.

Benjamin would have a net cash flow of: Cash received Tax savings from loss After tax net cash flow

$10,000 1,750 (Loss of $5,000  35% tax rate) $11,750

Ignoring the tax consequences, it appears that Benjamin should sell to his dad because he would receive $1,000 more for the equipment than if he sold to his friend. Once the tax consequences are considered, however, he is actually better off by $750 if he sells to his friend because the related party loss rules will not apply.

Time On Task: 10 minutes 2) Title: Tax Planning Problem 2 Difficulty: Hard Learning Objective 1: 15.2 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 15.2 Solution: The wash sale rule applies if a taxpayer sells stock at a loss and within 30 days before or after the date of sale purchases substantially identical stock. The loss is disallowed if that occurs. To avoid this rule and be able to recognize a loss, Dayana needs to wait until at least 30 days after the second purchase. Thirty days after April 25, Year 14 is May 26, Year 14.

Time On Task: 4 minutes 3) Title: Tax Planning Problem 3 Difficulty: Hard Learning Objective 1: 15.3 Standard 1: AACSB || Analytic Standard 2: AICPA || BC: Strategic Perspective Standard 3: Bloom's || Analysis Section Reference 1: 15.3 Solution: Yes, a delayed like-kind exchange is acceptable. Three requirements must be met:

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1. Both properties must be of a like kind, real property for real property.

2. The new property must be identified within 45 days of the transfer of the old property to a qualified intermediary.

3. The new property must be received within 180 days of the date when the old property was transferred to a qualified intermediary, or, if earlier, by the due date (including extensions) for the tax return covering the year of transfer.

Time On Task: 5 minutes 4) Title: Tax Planning Problem 4 Difficulty: Hard Learning Objective 1: 15.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 15.6 Solution: Boston—Realized gain is $275,000: Amount realized $500,000 Less: Adjusted basis (225,000) Realized gain $275,000 Recognized gain is $25,000. Kashif is eligible for the gain exclusion because he meets the ownership and use tests. He can use the $250,000 exclusion to offset his realized gain of $275,000.

Hilton Head—Realized gain is $300,000: Amount realized $700,000 Less: Adjusted basis (400,000) Realized gain $300,000 Recognized gain is $300,000. Kashif does not meet the ownership and use tests because he lived in the home for only 19 months.

Pebble Beach—Realized gain is $400,000: Amount realized $1,200,000 Less: Adjusted basis (800,000) Realized gain $ 400,000 Recognized gain is $150,000. Kashif is eligible for the gain exclusion because he meets the ownership and use tests. He can use $250,000 exclusion to offset his realized gain of $400,000. The gain exclusion can only be used once every two years. Because the

15-33

exclusion was not used for the Hilton Head property, Kashif may use it for the Pebble Beach property.

Time On Task: 10 minutes Communication Problem 1) Title: Communication Problem: What Qualifies for a Like-Kind Exchange?

Difficulty: Medium Learning Objective 1: 15.3 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 15.3 Solution: Dear Sharon, Thank you for your email requesting assistance in determining what assets are qualified like-kind exchange property and possible deferral of gain/loss. I will need additional information to provide the best answer.

Only exchanges of real property for real property qualify for like-kind exchange treatment. You may exchange your land located in Bradenton and Alpharetta for other realty in separate exchanges or one exchange. In the list of items you provided, items 1, 2, and 5 are considered personalty and do not qualify for deferral of gain/loss.

To compute your realized gain/loss, I need to calculate the amount realized by you in the exchange. I will need the fair market value of all the assets you plan to receive in the exchange.

If you should receive any assets other than real property in the exchange, including cash, you may have to recognize some gain. I will also need to know if there is a mortgage outstanding that you will be relieved of or if you will be assuming a mortgage in the exchange. You have provided the adjusted basis of the assets that will be given up in the exchange, and I will use that to determine the realized gain or loss. I also will need to determine the holding period of the assets received so please provide the date of purchase for the assets given up.

You may need to use a third-party intermediary to locate properties for you to receive in the exchange. You would transfer the property you want to exchange to the third-party and then the new like-kind property you will receive must be identified within 45 days of the date you transferred your property. Also, the new property must be received within 180 days of the date when your property was transferred or if earlier, by the due date of the tax return in which the transfer took place. If you would like more information about this, let me know.

I look forward to hearing from you and working with you on this transaction.

Sincerely, Carnes & Youngberg, CPAs 15-34

Time On Task: 15 minutes Ethics Problem 1) Title: Ethics Problem: Sale of a Principal Residence Difficulty: Medium Learning Objective 1: 15.6 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 15.6 Solution: When Sly sold a principal residence sometime during the last three years, he may have incurred a gain that should have been recognized. Also, if Sly did exclude gain from the sale of a principal residence within the last two years of the sale date in 2024, the amount of gain he can exclude from the 2024 sale could be limited. Brad has an obligation to inform Sly that he may need to amend his 2021 and/or 2022 tax returns and that he may not be able to exclude the 2024 gain depending on the facts and determination for 2021 and 2022.

Brad has an obligation to himself as the preparer to accurately prepare Sly’s tax returns, and to ensure that recent prior years’ tax returns are correct. If Sly does not agree to amend a prior year return, if necessary, and report any required gain in 2024, Brad should resign from the engagement.

Per the AICPA’s Statements of Standards on Tax Services No. 1.2.6, Knowledge of Errors, "A member should promptly inform a taxpayer upon becoming aware of the taxpayer’s failure to file a required return, [or] an error in a previously filed return." Under SSTS No. 1.2.8, Brad cannot inform the IRS of Sly’s decisions due to confidentiality.

Time On Task: 15 minutes Research Problem 1) Title: Research Problem: Requirements for a Like-Kind Exchange Difficulty: Hard Learning Objective 1: 15.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 15.1 Solution: Yes, this is a qualified like-kind exchange. Three requirements must be met: a. Both properties must be of a like-kind, real property for real property. b. The new property must be identified within 45 days of the transfer of the old property to a qualified intermediary such as the third-party accommodator. c. The new property must be received within the earlier of 180 days of the date when the old property was transferred to a qualified intermediary, or the due date (including extensions) for the tax return covering the year of transfer.

15-35

In this example, Chase is entering a reverse like-kind exchange, also called a “Reverse” Starker exchange because the court case that set the precedent for allowing this was Starker v. United States. A reverse exchange is a transaction in which the taxpayer has located replacement property (Memphis property) he wishes to acquire but has not sold his relinquished property (Nashville). In a reverse exchange, the taxpayer acquires the replacement property by “parking” it with an accommodator until the relinquished property can be sold.

Requirements a. and b. have already been met. Chase has 180 days or until February 10 of next year to sell his Nashville property and to close and receive title to the Memphis property.

IRC §1031(a)(3) Starker v. United States, 602 F.2d 1341 (9th Cir. 1979).

Rev. Proc. 2004-51, 2004-2 CB 294 Time On Task: 20 minutes Excel Problem 1) Title: Excel Problem: Related-Party Sale Difficulty: Medium Learning Objective 1: 15.1 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 15.1 Solution: The disallowed loss from a related-party sale creates a right of offset, which taxpayers can use to reduce a gain upon the ultimate sale of the property to an unrelated taxpayer. The right of offset cannot create a loss, nor can it make a loss greater. Once the related-party buyer sells the asset to a third party, the buyer permanently loses any unused right of offset.

1.

Input: Original Cost Related Party Sale Proceeds Related Party Loss Amount realized Amount realized Less: Adjusted basis Realized gain Less: Right of offset Recognized gain

40,000 32,000 (8,000) 42,000 $42,000 (32,000) $10,000 ( 8,000) $ 2,000

2.

Input: 15-36

Original Cost Related Party Sale Proceeds Related Party Loss Amount realized Amount realized Less: Adjusted basis Realized gain Less: Right of offset Recognized gain

40,000 32,000 (8,000) 36,000 $36,000 (32,000) $ 4,000 ( 4,000) $ 0

3.

Input: Original Cost Related Party Sale Proceeds Related Party Loss Amount realized Amount realized Less: Adjusted basis Realized loss Less: Right of offset Recognized loss

40,000 32,000 (8,000) 30,000 $ 30,000 ( 32,000) ($ 2,000) ( 0) ($ 2,000)

Time On Task: 20 minutes

15-37

1) Title: CPA Exam Preparation: Enhanced Task-Based Simulation: Property Transactions Difficulty: Medium Learning Objective 1: 15.1, 3-6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 15.1, 3-6 Solution: Asset Sales

Gain/Loss

1. Reggie and Regina sold their principal residence for $750,000.

Their purchase price 25 years ago was $275,000.

100% excluded

2. RAC exchanged a building (FMV $235,00, basis $135,000) for a piece of land (FMV $235,000, basis, $160,000) to be used in the business.

100% deferred

3. RAC had a business storage shed destroyed by a recent tornado. The storage shed had a basis of $57,000. Fortunately, RAC had replacement insurance and received a check for $70,000. RAC purchased a new shed for $65,000.

Partially recognized

4. Reggie’s aunt died and left the Rinker’s her vacation property in Fort Myers, FL (FMV $385,000, Basis $265,000).

100% excluded

5. Regina sold her Disney stock to her daughter for $37,000.

Regina’s basis in the stock is $43,000.

100% excluded

6. RAC exchanged equipment (FMV $7,000, basis $6,000) for machinery (FMV $7,000, basis $5,000).

All recognized

7. Reggie and Regina sold their 2015 Jeep Cherokee for $12,000.

Their original purchase price was $17,500.

100% excluded

8. RAC sold business use equipment for $75,000. The equipment was purchased for $100,000 and has a basis of $0.

All recognized

9. RAC exchanged land (FMV $215,000, basis $183,000) for a warehouse (FMV $190,000, basis $125,000) and cash of $25,000 to be used in the business.

Partially recognized

Time On Task: 20 minutes Rationale for Answers: 1. A realized gain on the sale of a principal residence is taxable. However, taxpayers meeting the principal residence gain exclusion requirements are allowed to exclude up to $250,000 for single 15-38

filers and up to $500,000 for married filing jointly. To meet the exclusion requirements, the residence must have been used and owned for at least two years during the five-year period ending on the date of the sale.

2. Nontaxable exchange treatment is required if the property is like-kind property, and the form of the transaction is an exchange. Like-kind exchanges apply to real property used only for business or investment purposes. The building and land are both real property and qualify for nontaxable exchange treatment, so the gain is deferred.

3. The realized gain is $13,000 (Amount realized $70,000 − Adjusted basis $57,000). The destruction of the shed by a tornado qualifies as an involuntary conversion. Realized gain is deferred to the extent that the taxpayer reinvests the amount realized in replacement property. If the amount reinvested in replacement property is less than the amount realized, the realized gain is recognized to the extent of the deficiency. RAC did not reinvest $5,000 ($70,000 − $65,000) in qualifying replacement property. RAC’s recognized gain is $5,000, the lower of $13,000 or $5,000.

4. Inheritances are not considered income for federal tax purposes. The basis of inherited property is generally the property’s fair market value at the date of death. It is considered a reportable transaction when the property is sold.

5. Losses on transactions between related parties are disallowed. Regina’s realized loss is $6,000 ($47,000 − $53,000) but her recognized loss is zero because Regina and her daughter are related parties.

6. Like kind exchange treatment applies to real property used only for business or investment purposes. The equipment and machinery are both personalty and not real property and do not qualify for nontaxable exchange treatment. The realized gain of $1,000 (Amount realized $7,000 − Adjusted basis $6,000) is recognized.

7. The Jeep Cherokee is a personal use asset. Losses on the sale of personal use assets are not deductible.

8. Gain or loss from the sale of business use assets is reportable. The $75,000 gain on the sale of the equipment is fully includible in income.

9. The realized gain is $32,000 [Amount realized ($190,000 + $25,000) – Adjusted basis $183,000]. Nontaxable exchange treatment is required if the property is like kind property and the form of the transaction is an exchange. Like kind exchanges apply to real property used only for business or investment purposes. Because cash was received by RAC and is not like kind property, gain will be recognized on the lesser of: Realized gain, or Boot received

$32,000 $25,000

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Chapter 16—Personal Tax Credits End-of-Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Medium Learning Objective 1: 16.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.1 Solution: A tax credit is a dollar for dollar reduction of your tax liability. A tax deduction is beneficial to the extent of your marginal tax rate. Both will reduce your tax liability, but the credit provides more benefit and a greater reduction.

Time On Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Medium Learning Objective 1: 16.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.1 Solution: A tax credit is a dollar for dollar reduction of your tax liability, and the credit can be refundable, non-refundable, or partially refundable. A non-refundable credit will reduce your liability to zero, but not below. A refundable credit will reduce your liability to zero and you receive a refund for any remaining credit.

Time On Task: 2 minutes 3) Title: Discussion Question 3 Difficulty: Easy Learning Objective 1: 16.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.2 Solution: The child tax credit of $2,000 per eligible child can be completely phased out depending on your income level and filing status. If your AGI is less than $400,000 (MFJ) or less than $200,000 (all

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other filing statuses), you can reduce your liability by $2,000 per eligible child. Up to $1,700 of the child tax credit is refundable.

Time On Task: 2 minutes 4) Title: Discussion Question 4 Difficulty: Medium Learning Objective 1: 16.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.3 Solution: An individual does not need to be a child in order for the taxpayer to claim the credit for other dependents (family tax credit). A $500 nonrefundable credit is allowed for dependents who are not qualifying children for purposes of the child tax credit. Examples include a parent who is a qualifying relative, and other dependent(s) who are qualifying relatives.

Time On Task: 3 minutes 5) Title: Discussion Question 5 Difficulty: Easy Learning Objective 1: 16.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.4 Solution: The dependent care credit is designed to provide a tax credit for a portion of the expenses incurred in caregiving while the taxpayer is employed. The dependent care credit percentage begins at 35% and can be reduced to as low as 20% based on AGI. The credit is never completely phased out due to high earnings.

Time On Task: 2 minutes 6) Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 16.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.5 Solution: The earned income credit is a complex method of providing financial support for low income taxpayers. The credit is refundable, and the credit percentage increases if the taxpayer maintains a home for qualifying children. The credit percentage is 7.65% for no qualifying children, 34%

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for one qualifying child, 40% for two qualifying children, and 45% for three or more qualifying children.

Time On Task: 3 minutes 7) Title: Discussion Question 7 Difficulty: Easy Learning Objective 1: 16.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.6 Solution: The American Opportunity Tax Credit (AOTC) is allowed up to maximum of $2,500 per year for each eligible student for the student’s first four years of postsecondary education. Qualified educational expenses are nondeductible tuition and fees. Course materials are also included. The AOTC can be completely phased out for high income earners.

Time On Task: 2 minutes 8) Title: Discussion Question 8 Difficulty: Easy Learning Objective 1: 16.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.6 Solution: The Lifetime Learning Credit (LLC) is computed as 20% of a maximum of $10,000 of qualified educational expenses incurred by the taxpayer, spouse, or dependent. The LLC can be completely phased out for high income earners.

Time On Task: 2 minutes 9) Title: Discussion Question 9 Difficulty: Easy Learning Objective 1: 16.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.7 Solution: Qualified adoption expenses include adoption fees, court costs, attorney fees, and other expenses that are directly related to the legal adoption by the taxpayer of an eligible child.

Time On Task: 2 minutes

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10) Title: Discussion Question 10 Difficulty: Easy Learning Objective 1: 16.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.7 Solution: Eligible taxpayers are those who are either (1) 65 or older or (2) permanently and totally disabled. The credit for the elderly or the disabled is nonrefundable.

Time On Task: 2 minutes 11) Title: Discussion Question 11 Difficulty: Easy Learning Objective 1: 16.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.7 Solution: The Saver’s Credit is a maximum $1,000 credit allowed for voluntary IRA and qualified retirement account contributions. The credit is phased out for high income taxpayers.

Time On Task: 2 minutes 12) Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.7 Solution: The energy credits include: Individual taxpayers are allowed two credits for expenditures for installing certain energy efficient property in the taxpayer’s residence. The first is the Residential Clean Energy (RCE).

This credit is nonrefundable, but it can be carried forward for one year. The RCE credit allowed for 2024 is 30% of qualified solar electric, solar water heating, fuel cell, small wind energy, geothermal heat pump, and battery storage technology expenditures. The residence must be located in the United States for the credit to be claimed. The credit can also be claimed against the alternative minimum tax.

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Individuals can also claim the Energy Efficient Home Improvement Credit, equal to 30% of expenditures for home energy audits, advanced main air circulating fans, for qualified natural gas, propane, or oil furnace or hot water boilers, and for heat pumps, water heaters, and central air conditioners, paid or incurred by the taxpayer during that tax year. In general, the maximum credit allowed per year is $1,200. The credit is available only for property installed on the taxpayer's home located in the United States.

The nonrefundable Clean Vehicle Credit encourages individuals to purchase electric vehicles.

This credit is part of the general business credit if the purchase incurred is part of a business operation. In that case, it can be carried back for one year and carried forward for 20 years. If the purchase is related to one’s personal life, there is no carryback or carryforward. The following requirements apply: •

• •

• •

The maximum credit is $7,500. A credit of $3,750 is available if a critical minerals requirement is met for the battery, and an additional $3,750 is available for meeting a battery component requirement. The purpose of these requirements is to encourage manufacturers to move their battery supply chains from China to the U.S. or countries that have a free trade agreement with the U.S. The vehicle must be new.

Final assembly must have taken place in North America. The previous limit on the number of vehicles eligible per manufacturer has been removed. GM and Tesla had been limited to this cap in the past, so as of 2023, purchasers of qualifying cars from these manufacturers are eligible for the credit again.

The credit is not allowed for cars with a manufacturer's suggested retail price of over $55,000, or over $80,000 for vans, SUVs, and pickup trucks.

Taxpayers with modified AGI above the following amounts are not eligible for the credit: Married Filing Jointly—$300,000; Head of Household—$225,000; Single & Married Filing Separately—$150,000.

Time On Task: 6 minutes 13) Title: Discussion Question 13 Difficulty: Easy Learning Objective 1: 16.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.7 Solution: Yes, the United States includes income from all sources in taxable income, including income from foreign countries which can create double taxation. The purpose of the foreign tax credit is to mitigate the double taxation of income taxed in the U.S. and also taxed in a foreign country.

The credit is limited to the lower of: 1. foreign tax paid, or

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2. U.S. tax on worldwide income × (Foreign source taxable income / Worldwide taxable income) The second part of this formula is referred to as the foreign tax credit limitation. The excess of the foreign taxes paid in excess of the foreign tax credit limitation can be carried back one year and carried forward for 10 years. The foreign tax credit is claimed on Form 1116.

Time On Task: 3 minutes Multiple Choice Questions 1) Answer: a Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 16.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.1 Solution: The correct answer is Earned Income Tax Credit.

The earned income credit is refundable while the elderly credit, personal energy credit, and foreign tax credit are not refundable.

Time On Task: 2 minutes 2) Answer: a Title: Multiple Choice Question 2 Difficulty: Easy Learning Objective 1: 16.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.2 Solution: The correct answer is The credit is $500 per qualifying child.

The child tax credit is $2,000 per qualifying child, not $500. The amount of credit is reduced if modified adjusted gross income exceeds certain thresholds. To qualify for the credit, a dependent child must be less than 17 years old. A qualifying child must be a U.S. citizen or resident.

Time On Task: 2 minutes 3) Answer: b Title: Multiple Choice Question 3 Difficulty: Medium Learning Objective 1: 16.3 Standard 1: AACSB || Analytic 16-6

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.3 Solution: The correct answer is $500.

Brielle can take a $500 credit for other dependents (family tax credit) for her father on her tax return. The credit is nonrefundable.

Time On Task: 2 minutes 4) Answer: a Title: Multiple Choice Question 4 Difficulty: Medium Learning Objective 1: 16.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.4 Solution: The correct answer is After-school expenses for your 10-year-old daughter to be supervised until you can pick her up when you get off work.

After-school expenses for your 10-year-old daughter to be supervised until you can pick her up when you get off work qualify for the dependent care credit. She meets the age test, and it is enabling you to work. Tuition for your 12-year old son to go to a private elementary school does not qualify because expenses paid for education do not qualify. Payments to a nursing home for a 35-year-old dependent who needs to be cared for but is not mentally or physically incapacitated does not qualify because the dependent is not mentally or physically incapacitated. Payments to a housekeeper who cleans your home and supervises your children while your spouse goes to the spa twice each week (spouse does not work) do not qualify because only expenses so your spouse can be gainfully employed or attending higher education qualify.

Time On Task: 4 minutes 5) Answer: d Title: Multiple Choice Question 5 Difficulty: Medium Learning Objective 1: 16.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.5 Solution: The correct answer is All of the statements are true.

Depending on the taxpayer's earned income and filing status, the earned income credit can be completely phased out. If disqualified income exceeds $11,600 (2024), the earned income credit is disallowed. Earned income includes wages, salaries, tips, and earnings from self-employment.

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Time On Task: 3 minutes 6) Answer: b Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 16.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.6 Solution: The correct answer is The AOTC can be claimed only for expenses of the taxpayer, but the LLC can be claimed for the taxpayer, the taxpayer’s spouse, and the taxpayer’s dependents.

Both credits apply to the taxpayer, the taxpayer’s spouse, and the taxpayer’s dependents. The other choices are all true statements.

Time On Task: 4 minutes 7) Answer: c Title: Multiple Choice Question 7 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.7 Solution: The correct answer is Limited to the regular tax liability in the current year and carried forward for five years.

The adoption credit is not currently refundable, but it may be carried forward for five years.

Time On Task: 4 minutes 8) Answer: b Title: Multiple Choice Question 8 Difficulty: Easy Learning Objective 1: 16.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.7 Solution: The correct answer is 15% of an initial amount based on filing status.

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The credit for the elderly or the disabled is for eligible taxpayers who are either (1) 65 or older or (2) permanently and totally disabled. The credit is 15% of an initial amount reduced by certain amounts excluded from gross income and AGI in excess of certain levels.

Time On Task: 2 minutes 9) Answer: a Title: Multiple Choice Question 9 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.7 Solution: The correct answer is $1,000.

The Saver’s Credit is a maximum of $1,000. Qualifying taxpayers multiply their IRA contribution by 50%, 20%, or 10% depending on the level of AGI. Because of Ming’s low AGI, she has a $1,000 credit available, $3,000  50%, not to exceed $1,000. The maximum contribution to an IRA is $2,000 for the Retirement Savings Contributions Credit. Thus, $2,000  50% = $1,000 maximum credit.

Time On Task: 3 minutes 10) Answer: c Title: Multiple Choice Question 10 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 16.7 Solution: The correct answer is Both qualified solar electric property expenditures and qualified electric motor vehicles.

Qualified solar electric property expenditures and qualified electric motor vehicles are both qualified expenditures for energy tax credits.

Time On Task: 3 minutes Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 16.1 Standard 1: AACSB || Analytic

16-9

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.1 Solution: Lane should choose the $2,500 refundable credit. The $10,000 deduction would provide only a $2,200 tax benefit ($10,000  22%).

Time On Task: 3 minutes 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 16.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.1 Solution: Victor must calculate his taxable income first, and then calculate his tax liability.

AGI Less: Standard deduction (HOH) Taxable income

$68,000 (21,900) (Greater than his itemized deductions) $46,100

Victor’s federal tax liability before credits is $5,201 using the 2024 head of household tax table. [($46,100 – 16,550) × 12% + $1,655 = $5,201] His net federal tax due is $501 ($5,201 − $2,500 federal tax withheld − $2,200 refundable tax credit).

Time On Task: 4 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 16.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.2 Solution: Jade’s allowable child tax credit is $450.

AGI Threshold Excess

$231,000 (200,000) $ 31,000/$1,000 = 31  $50 = $1,550 Phaseout

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Available child tax credit Less: Phaseout Allowable child tax credit Time On Task: 4 minutes

$2,000 (1,550) $ 450

4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 16.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.3 Solution: Denise can claim the credit for other dependents (family tax credit) for both her father and her daughter. The daughter does not qualify for the child tax credit because she is 21 years old.

Denise’s total family tax credit is $1,000 ($500  2).

Time On Task: 4 minutes 5) Title: Brief Exercise 5 Difficulty: Medium Learning Objective 1: 16.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.4 Solution: Clarence and Susan are eligible for the dependent care credit because the daughter is under the age of 13 and both parents are employed. Because their AGI is in excess of $43,000, the credit percentage is 20%. To calculate the credit, use the lesser of $8,400 (amount spent) or $3,000 (standard amount available for one child) and multiply by 20%. The dependent care credit is $600 ($3,000  20%).

Time On Task: 4 minutes 6) Title: Brief Exercise 6 Difficulty: Easy Learning Objective 1: 16.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.5 Solution:

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Jordy cannot claim the earned income credit because he is not at least 25 years old. In addition, his earned income exceeds the fully phased-out amount ($18,591 for 2024) for taxpayers with no children.

Time On Task: 2 minutes 7) Title: Brief Exercise 7 Difficulty: Easy Learning Objective 1: 16.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.6 Solution: Rishaan’s American Opportunity Tax Credit is $2,500. Rishaan qualifies for the AOTC which is 100% for the first $2,000 paid and 25% for the next $2,000 paid ($2,000 + $500). None of the credit is phased out because Rishaan’s AGI is below the phaseout range.

Time On Task: 4 minutes 8) Title: Brief Exercise 8 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.7 Solution: The available adoption credit in 2024 for an adopted child is $16,810. Because the child has special needs, the couple may claim an adoption credit of $16,810 even though they paid only $12,000. Their AGI is below the threshold of $252,150 (2024) so the credit will not be phased out. The adoption credit can be claimed in 2024, the year that the adoption was finalized.

Time On Task: 4 minutes 9) Title: Brief Exercise 9 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.7 Solution: Dennis can claim a credit for the elderly and disabled of $38 calculated as follows: Initial amount (single)

$5,000

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Less: Social security income $4,000 50% of AGI > $7,500 $ 750 Balance Amount of credit (limited to tax liability) Time On Task: 4 minutes

( 4,750) $ 250  15% $ 38

10) Title: Brief Exercise 10 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.7 Solution: Desmond will be able to claim a Saver’s Credit of $900 (Lesser of $1,000 or 50% of $1,800 contribution). Desmond’s adjusted gross income is eligible for the 50% credit rate.

Time On Task: 4 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium Learning Objective 1: 16.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.1 Solution: Sherry’s net federal tax liability is $519 calculated as follows: Adjusted gross income $52,000 Less: Itemized deductions ( 15,000) (greater than standard deduction of $14,600) Taxable income $37,000 Federal tax liability is computed as follows: [($37,000 − $11,600) × 12% + $1,160] = $4,208 Federal tax liability (single) $ 4,208 ( Less: Federal tax withheld ( 2,800) Less: Refundable credit ( 1,000) Net federal tax liability $ 408 Time On Task: 5 minutes 2) Title: Application Problem 2

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Difficulty: Medium Learning Objective 1: 16.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.1 Solution: Benson’s refund is $2,750 calculated as follows: Federal tax liability $ 2,500 Non-refundable credits ( 2,500) Limited to federal tax liability Federal income tax withheld ( 1,750) Refundable credits ( 1,000) Net refund ($ 2,750) The remaining non-refundable credit of $500 ($3,000 − $2,500) cannot be carried forward for most non-refundable credits but not all non-refundable credits.

Time On Task: 5 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 16.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.2 Solution: The child tax credit is $2,000 per qualifying child. Qualifying children must be less than 17 and meet the same definition as is used for the dependency rules. Therefore, the Denkins will receive a credit for Tessa because she is a niece, and also for Holly and Ivy. Before the phaseout, the Denkins’ credit is $6,000 (3 × $2,000). The credit is reduced by $50 for each $1,000 (or part thereof) of excess AGI. The phaseout of credit begins at AGI of $400,000 for taxpayers filing married joint ($200,000 for single).

The excess AGI is $26,400 ($426,400 − $400,000). The excess of $26,400 is divided by $1,000 and provides 26.4 increments, which is increased to 27 (any portion of a $1,000 increment counts as a full increment). Therefore, the Denkins lose $1,350 of their credit (27 × $50). Their final child tax credit is $4,650 ($6,000 − $1,350).

Time On Task: 6 minutes

4)

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Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 16.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.2 Solution: a. The child tax credit is $2,000 per qualifying child. Qualifying children must be less than 17.

Therefore, Shakira has two qualifying children under age 17.

Before phaseout, Shakira’s credit is $4,000 (2 × $2,000). The credit is reduced by $50 for each $1,000 (or part thereof) of excess AGI. The phaseout of credit begins at AGI of $200,000 for single taxpayers. Since Shakira’s AGI is only $185,000, she can claim the entire child tax credit of $4,000. b. The child tax credit is $2,000 per qualifying child. Qualifying children must be less than 17.

Therefore, Shakira has two qualifying children under age 17.

Before the phaseout, Shakira’s credit is $4,000 (2 × $2,000). The credit is reduced by $50 for each $1,000 (or part thereof) of excess AGI. The phaseout of credit begins at AGI of $200,000 for single taxpayers.

The excess AGI is $15,000 ($215,000 − $200,000). The excess of $15,000 is divided by $1,000 and provides 15 increments. Therefore, Shakira loses $750 of her credit (15 × $50). Her final child tax credit is $3,250 ($4,000 − $750).

Time On Task: 6 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 16.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.2 Solution: a. Yes, a qualifying child (QC) because the daughter meets the dependency requirements and is under the age of 17. b. No, the parent is a dependent, but is not a QC. c. No, son is a dependent, but he is not under the age of 17. d. Yes, a QC because the son meets the dependency requirements and is under the age of 17. Earnings are not considered. e. Yes, a QC because the nephew meets the dependency requirements and is under the age of 17.

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Time On Task: 5 minutes 6) Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 16.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.3 Solution: The Sampsons can claim the child tax credit for Cindy of $2,000 because she is under the age of 17 and a dependent. They can also claim the credit for other dependents (family tax credit) for both Samuel and the grandmother for a total of $1,000 ($500  2). Samuel is under the age of 24 and a full-time college student and the grandmother is a qualifying relative.

Time On Task: 4 minutes 7) Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 16.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.3 Solution: Gino can claim the credit for other dependents (family tax credit) for both Antony and his mother. Both Antony and his mother are qualifying relatives because Gino provides greater than 50% support and both meet the gross income test.

Time On Task: 3 minutes 8) Title: Application Problem 8 Difficulty: Medium Learning Objective 1: 16.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.4 Solution: Renee can claim a dependent care credit of $1,653 calculated as follows: We first determine the correct credit percentage to use: AGI Threshold

$27,000 (15,000)

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Excess

$12,000

The excess of $12,000/$2,000 = 6.0 units so her credit percentage is 29% (35% − 6%).

Next, we determine the limit of eligible expenses to be the lowest of: 1. Qualifying expenses paid 2. Earned income, or 3. Amount eligible (2 children)

$ 5,700 $25,000 $ 6,000

The amount paid to her mother is an eligible expense if her mother is not her dependent. The $12,500 paid to the parochial school is not an eligible expense.

Finally, we multiply the limit of eligible expenses by the correct credit percentage: $5,700  29% = $1,653 dependent care credit.

Time On Task: 8 minutes 9) Title: Application Problem 9 Difficulty: Medium Learning Objective 1: 16.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.4 Solution: a. If Mrs. Russell has zero earned income, then the Russells' dependent care credit is zero.

A married couple is eligible for this credit only if both spouses are gainfully employed (or if one spouse is either a full-time student or is physically or mentally incapacitated). b. We first determine the correct credit percentage to use: AGI Threshold Excess

$125,000 ( 15,000) $110,000

Excess of $110,000/$2,000 = 55 which exceeds 35%, so the Russells will use the minimum 20% to compute the credit.

Next, we determine the limit of eligible expenses to be the lowest of: 1. Qualifying expenses paid 2. Earned income, or 3. Amount eligible (2 children)

$ 9,300 $ 4,700 $ 6,000

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Finally, we multiply the limit of eligible expenses by the correct credit percentage: Multiply $4,700  20% = $940 dependent care credit.

Time On Task: 6 minutes 10) Title: Application Problem 10 Difficulty: Medium Learning Objective 1: 16.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.4 Solution: You must determine what is an eligible expense. The qualifying amount paid is for the care of the 11-year-old of $2,900. The other children are not under the age of 13 so their care does not qualify for the credit. Only expenses paid to an individual who is not the Tuckers' dependent are qualifying expenses so the $3,200 paid to the 17-year-old does not qualify.

We first determine the correct credit percentage to use. Because the Tucker’s adjusted gross income is above $43,000, they must use the 20% rate to compute the credit.

Next, we determine the limit of eligible expenses to be the lowest of: 1. Qualifying expenses paid 2. Earned income, or 3. Amount eligible (1 child)

$ 2,900 $44,000 $ 3,000

Finally, we multiply the limit of eligible expenses by the correct credit percentage: Therefore, their dependent care credit is $580 ($2,900  20%).

Time On Task: 6 minutes 11) Title: Application Problem 11 Difficulty: Medium Learning Objective 1: 16.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.4 Solution: Dalvin is not entitled to a dependent care credit. The recipient of the income must report the income on her tax return and Dalvin must report the caregiver’s Social Security number on Form 2441 in order for Dalvin to claim the credit.

Time On Task: 3 minutes 16-18

12) Title: Application Problem 12 Difficulty: Medium Learning Objective 1: 16.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.4 Solution: We first determine the correct credit percentage to use.

Nadine’s adjusted gross income is $30,000.

AGI Threshold Excess

$30,000 (15,000) $15,000

Excess of $15,000/$2,000 = 7.5 which rounds to 8, so her credit percentage is 35% − 8% = 27%.

Next, we determine the limit of eligible expenses to be the lowest of: 1. Qualifying expenses paid 2. Earned income, or 3. Amount eligible (2 children)

$ 8,000 $30,000 $ 6,000

The childcare ceiling amount of $6,000 is reduced to $1,000 by the $5,000 employer reimbursement.

Finally, we multiply the limit of eligible expenses by the correct credit percentage: Multiply the $1,000 ($6,000 − $5,000 reimbursement)  27% = $270 dependent care credit.

Time On Task: 6 minutes 13) Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 16.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.5 Solution: a. Laurel can claim an earned income credit of $4,008 $4,213 ($12,390  34%) reduced by $205 [($24,000 − $22,720)  15.98%] b. Laurel can claim an earned income credit of $7,560

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$7,830 ($17,400  45%) reduced by $270 [($24,000 − $22,720)  21.06%] Time On Task: 6 minutes 14) Title: Application Problem 14 Difficulty: Medium Learning Objective 1: 16.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.5 Solution: a. The Hashids can claim an earned income credit of $6,463. $6,960 ($17,400  40%) reduced by $497 [($32,000 − $29,640)  21.06%] b. The Hashids can claim an earned income credit of $0. $6,960 ($17,400  40%) reduced by $7,447 [($65,000 − $29,640)  21.06%] The Hashids' earned income is above the phaseout threshold of $62,688 so the earned income credit is completely phased out.

Time On Task: 6 minutes 15) Title: Application Problem 15 Difficulty: Medium Learning Objective 1: 16.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.6 Solution: a. Zaira and Lionel can claim an American Opportunity Tax Credit of $2,500 Tuition and fees paid were $22,800 ($22,000 + $800). Room and board are not eligible expenses. (100%  $2,000) + (25%  $2,000) = $2,500. Their adjusted gross income is below the phaseout threshold so they may claim the entire credit. b. Zaira and Lionel can claim an American Opportunity Tax Credit of $500 Tuition and fees paid were $22,800 ($22,000 + $800). Room and board are not eligible expenses. (100%  $2,000) + (25%  $2,000) = $2,500, however, their adjusted gross income exceeds the threshold, and a portion of the credit is phased out. [($176,000 − $160,000)/$20,000] = 80%. 80% of the credit is phased out; therefore, the maximum available AOTC is $500 ($2,500  20% allowable portion) Time On Task: 6 minutes 16) Title: Application Problem 16 Difficulty: Easy Learning Objective 1: 16.6 Standard 1: AACSB || Analytic

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Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.6 Solution: Mr. and Mrs. Jenkins can claim the American Opportunity Tax Credit for Bud who attends college. The AOTC is available for the first four years of post-secondary education. Their credit is $2,500 (100%  $2,000) + (25%  $2,000). They cannot claim the AOTC for Helga because her private high school is not post-secondary education.

Time On Task: 5 minutes 17) Title: Application Problem 17 Difficulty: Medium Learning Objective 1: 16.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.6 Solution: a. Rosie can claim a Lifetime Learning Credit of $1,300. She would have used her AOTC for her four years earning her Bachelor of Science degree. Rosie’s LLC is $1,300 ($6,500  20%). She can claim the entire $1,300 because her adjusted gross income is below the phaseout range. b. Rosie can claim a Lifetime Learning Credit of $130. She would have used her AOTC for her four years earning her Bachelor of Science degree. Rosie’s LLC is $1,300 ($6,500  20%). However, a portion of the LLC is phased out because her adjusted gross income exceeds $80,000. [($88,000 − $80,000)/$10,000] = 80%. Therefore, 80% of the credit is phased out and the maximum available LLC is $260 ($1,300  20% allowable portion) Time On Task: 6 minutes 18) Title: Application Problem 18 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.7 Solution: Jamie and David paid $17,000 in qualified expenses, but the limit for the credit is $16,810 in 2024. Because their adjusted gross income exceeds the start of the phaseout range, a portion of the adoption credit is phased out. [($255,000 − $252,150)/$40,000] = 7.13% (rounded).

Therefore, the maximum adoption credit is $15,611 ($16,810  92.87% allowable portion). The adoption credit is claimed in 2024, the year that the adoption was finalized.

Time On Task: 5 minutes

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19) Title: Application Problem 19 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.7 Solution: The available adoption credit in 2024 for an adopted child is $16,810. Because the child has special needs, Khalil may claim an adoption credit of $16,810 even though he paid only $12,200 in qualified expenses. Khalil's AGI is below the threshold of $252,150 (2024) so the credit will not be phased out. The adoption credit is claimed in 2024, the year the adoption was finalized.

Khalil’s federal tax liability is $4,300. He can use $4,300 of the adoption credit to reduce his 2024 tax liability to zero. The adoption credit is non-refundable but the unused credit of $12,510 can be carried forward for five years.

Time On Task: 6 minutes 20) Title: Application Problem 20 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.7 Solution: Lewis can claim a credit for the elderly or the disabled of $150 calculated as follows: Initial amount (single) $5,000 Less: Disability income $4,000 50% of AGI > $7,500 $ 0 ( 4,000) Balance $1,000  15% Amount of credit (limited to tax liability) $ 150 Time On Task: 5 minutes 21) Title: Application Problem 21 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.7 Solution:

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Akiem and Mia can claim $800 for the Saver’s Credit. The eligible retirement plan contributions for purposes of the Saver’s Credit is limited to $2,000 for Akiem and $2,000 for Mia. And the Saver’s Credit based on their AGI and filing status is limited to 20% of the contributions, or $800 ($4,000  20%).

Time On Task: 4 minutes 22) Title: Application Problem 22 Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 16.7 Solution: Tanisha’s foreign tax credit is limited to the lower of: 1. foreign tax paid of $38,000, or 2. U.S. tax on worldwide income × (Foreign source taxable income / Worldwide taxable income) $105,000 × (86,000/ ($86,000 + $127,000)) = $42,394.

Therefore, Tanisha’s Foreign Tax Credit is not limited since the Foreign Tax Paid of $38,000 is less than the Overall Limitation of $42,394. Thus, the Foreign Tax Credit for Tanisha for the current tax year is $38,000 and there is no need to carryback or carry forward any of the Foreign Tax Credit to past or future tax years.

Time On Task: 5 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Medium Learning Objective 1: 16.4 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 16.4 Solution: Cash received from teaching Taxes paid at 22% Caregiver expenses paid Dependent care credit

$42,000 ( 9,240) ( 10,000) 1,200*

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Net cash flow

$23,960

Because Daren and Leila’s AGI is $124,000, their credit percentage has been reduced from 35% to 20%, the lowest the percentage can be. *Determine lower of: 1. Qualifying expenses paid 2. Earned income, or 3. Amount eligible (2 children)

$10,000 $42,000 $ 6,000

Therefore, their dependent care credit is $1,200 (20%  $6,000) Time On Task: 8 minutes 2) Title: Tax Planning Problem 2 Difficulty: Medium Learning Objective 1: 16.6 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 16.6 Solution: Assuming Tarik’s main goal is reducing his tax liability, Tarik should choose to spend the $5,000 on the charitable contribution. He will reduce his tax liability by $1,100 ($5,000  22%) if he chooses to make a $5,000 charitable contribution and increase his itemized deductions. He will reduce his tax liability by $1,000 ($5,000  20%) if he chooses to spend the $5,000 on more education and receive the Lifetime Learning Credit. Choosing the charitable contribution will produce $100 greater tax savings for Tarik than the education credit.

Time On Task: 8 minutes Communication Problem 1) Title: Communication Problem: Adoption Credit Difficulty: Medium Learning Objective 1: 16.7 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 16.7 Solution: Memo to Client Hello Fang,

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Congratulations on adopting your baby boy!! That is exciting news! And thank you for letting me assist you in calculating your adoption credit. Qualified adoption expenses incurred or paid prior to the year the adoption is finalized are claimed as a credit in the year that the adoption is finalized. Qualified adoption expenses incurred or paid in the year the adoption becomes final or in the year following finalization of the adoption are claimed in the year they were incurred.

The limit for the adoption credit in 2024 is $16,810 and begins to phase out if your adjusted gross income (AGI) is in excess of $252,150. You paid $13,500 in the year before finalization and $6,300 in the year the finalization occurred. The total of $19,800 will be limited to a credit of $16,810 and will be claimed in 2024, the year of finalization. Because your AGI is below the phaseout range, this credit will not be phased out. You are entitled to claim an adoption credit of $16,810 in 2024.

Congratulations again on your new son, Sincerely, Carnes & Youngberg, CPAs Memo to the tax file Facts: Fang adopted a baby and paid $13,500 in 2023 and $6,300 in 2024 for qualified adoption expenses. The adoption will be finalized in 2024. Fang’s adjusted gross income is typically around approximately $137,000 per year.

Issues: 1. In which year can Fang claim the adoption credit?

2. How much is her adoption credit?

Conclusion: 1. Fang can claim the adoption credit in 2024, the year that the adoption was finalized.

2. The adoption credit in 2024 is $16,810 Analysis: 1. Per IRC §23(a)(2), qualified adoption expenses incurred or paid prior to the finalization year are claimed as a credit in the year that the adoption is finalized. Qualified adoption expenses incurred or paid in the year the adoption becomes final or in the year following finalization of the adoption are claimed in the year they were incurred.

2. Per IRC §23(b)(1), the adoption credit is $10,000. This number is adjusted for inflation and is currently at $16,810 in 2024. Fang can claim $16,810 in 2024.

Time On Task: 15 minutes Ethics Problem 1) Title: Ethics Problem: Education Credit Difficulty: Medium

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Learning Objective 1: 16.6 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 16.6 Solution: The AOTC is allowed up to a maximum of $2,500 per year for the first four years of postsecondary education for an eligible student. To be eligible for the AOTC, the student must be enrolled at least half-time in a degree program. Jed is not entitled to four more years of the AOTC just because the education is in a different discipline. You should advise Jed that he should amend last year’s return and not claim the AOTC. Jed is entitled to claim the Lifetime Learning Credit on last year’s return and the current year’s return. Under Statements on Standards for Tax Services No. 1.2.6, "A member should promptly inform a taxpayer upon becoming aware of the taxpayer’s failure to file a required return, [or] an error in a previously filed return." Under Circular 230, §10.21 Knowledge of client’s omission and §10.22 Diligence as to accuracy, it is the preparer’s responsibility to advise the client of the error and exercise due diligence with respect to accurately preparing the current tax return.

Time On Task: 8 minutes Research Problem 1) Title: Research Problem: Child Tax Credit Difficulty: Difficult Learning Objective 1: 16.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 16.2 Solution: Enrique and Liza can claim a child tax credit for all three children in the current year and the following year. A child tax credit is allowed for each qualifying child. In the current year, a $2,000 child tax credit is allowed for each qualifying child. To be eligible for the credit, the child must be under the age of 17, must be a U.S. citizen, and must be a dependent of the taxpayer.

The IRS criteria state that the child must have lived with you for the entire year, but there are special rules for the year a child is born and for a child who has died. The IRS considers a child who died during the year to have lived with you the entire year as long as he has lived with you from the beginning of the year to the time of death, or from the time of birth if the child was born during the current tax year (IRC §24(f) and IRS Publication 972).

Time On Task: 10 minutes Excel Problem 1) Title: Excel Problem: Child and Dependent Care Credit Difficulty: Medium Learning Objective 1: 16.2

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Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 16.2 Solution: Situation 1 The Kims can claim a child and dependent care credit of $1,000 calculated as follows: Determine lower of: 1. Qualifying expenses paid 2. Earned income (lesser of 2), or 3. Amount eligible (2 children)

$ 5,000 $22,000 $ 6,000

Multiply $5,000  20% = $1,000 child and dependent care credit. The adjusted gross income is above $43,000 so 20% is used to calculate the credit.

Situation 2 The Kims can claim a child and dependent care credit of $960 calculated as follows: Determine lower of: 1. Qualifying expenses paid 2. Earned income (lesser of 2), or 3. Amount eligible (2 children)

$10,000 $ 4,800 $ 6,000

Multiply $4,800  20% = $960 child and dependent care credit. The adjusted gross income is above $43,000 so 20% is used to calculate the credit.

Situation 3 The Kims can claim a child and dependent care credit of $945 calculated as follows: Determine lower of: 1. Qualifying expenses paid 2. Earned income (lesser of 2), or 3. Amount eligible (2 children)

AGI Threshold Excess

$30,000 ( 15,000) $15,000

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$ 3,500 $10,000 $ 6,000

Excess of $15,000/$2,000 = 7.5 which increases to 8. The 35% maximum is reduced by one percentage point for each $2,000 (or portion thereof) that AGI exceeds $15,000. Her credit rate is 35% − 8% = 27%. $3,500  27% = $945 child and dependent care credit.

Situation 4 The Kims can claim a child and dependent care credit of $0 calculated as follows: Determine lower of: 1. Qualifying expenses paid 2. Earned income (lesser of both spouses), or 3. Amount eligible (2 children) AGI Threshold Excess

$ 7,500 $ 0 $ 6,000

$40,000 (15,000) $25,000

Excess of $25,000/$2,000 = 12.5 which increases to 13, so her credit percentage is 35% − 13% = 22%. $0  22% = $0 child and dependent care credit. Because Lee’s earned income is zero and he is neither a full-time student or is physically or mentally incapacitated, no child and dependent care credit is allowed.

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Time On Task: 15 minutes CPA Exam Preparation: Task Based Simulation 1) Title: CPA Exam Preparation: Task Based Simulation 1: Child and Dependent Care Credit Difficulty: Medium Learning Objective 1: 16.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 16.4 Solution: Number of Qualifying Individuals

2

Qualifying Expenses

$6,000

Applicable Percentage for Computing Credit

20%

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Credit Amount

$1,200

To qualify for the credit, the expenses must be incurred to care for a dependent under the age of 13. Therefore, Ellie and Tucker are qualifying individuals, but Finley does not qualify because he is 14.

The amount of qualifying expenses is limited to $3,000 for one qualifying individual and $6,000 for more than one qualifying individual. Because they have two qualifying individuals their qualifying expenses are limited to $6,000. Note that qualifying expenses are also limited to the actual amount paid ($6,200) and the wages earned of the lower paid spouse ($14,000).

The qualifying expenses of $6,000 are multiplied by the applicable percentage, which ranges from 20–35%. The 35% maximum is reduced by one percentage point for each $2,000 (or portion thereof) that AGI exceeds $15,000. Once AGI exceeds $43,000, the percentage is reduced to its minimum of 20%, so the Fargos' applicable percentage is 20%.

The Fargos' credit is $6,000  20% = $1,200.

Time On Task: 10 minutes

CPA Exam Preparation: Task Based Simulation 2) Title: CPA Exam Preparation: Task Based Simulation 2: Education Credits Difficulty: Medium Learning Objective 1: 16.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 16.6 Solution:

Expenses qualifying for the American Opportunity Credit—Bam

2,000

Expenses qualifying for the American Opportunity Credit—Rock

3,000

Expenses qualifying for the American Opportunity Credit—Betty

0

Expenses qualifying for the Lifetime Learning Credit—Bam

0

Expenses qualifying for the Lifetime Learning Credit—Rock

0

Expenses qualifying for the Lifetime Learning Credit—Betty

4,500

American Opportunity Education Credit BEFORE any applicable phaseout

4,250

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American Opportunity Education Credit AFTER any applicable phaseout

4,250

Lifetime Learning Credit Education Credit BEFORE any applicable phaseout

900

Lifetime Learning Credit Education Credit AFTER any applicable phaseout

900

American Opportunity Credit Bam and Rock qualify for the American Opportunity credit because they are in their first four years of postsecondary education. Tuition and fees qualify for the credit, and required course fees, but not room and board. Therefore, Bam’s qualified expenses are $2,000 and Rock's are $3,000. The credit is 100% of the first $2,000 of qualified expenses and $25% of the next $2,000. The American Opportunity Credit is available per student.

Bam: $2,000 × 100% = $2,000 Rock: $2,000 × 100% = $2,000; $1,000 × 25% = $250; total is $2,250.

The total American Opportunity Credit is $2,000 + $2,250 = $4,250. There is no phaseout for this credit because the Rubbles' AGI of $124,000 does not exceed $160,000.

Lifetime Learning Credit The Lifetime Learning Credit applies for years after the first four years of postsecondary education. The credit applies for tuition and fees of the taxpayer, taxpayer's spouse, and dependents, so Betty's expenses do qualify. Qualified expenses are limited to $10,000 (for all qualified individuals combined, not per student). The credit allowed is 20% of qualified expenses, so the Rubbles' credit is $4,500  20% = $900. There is no phaseout for this credit because the Rubbles' AGI of $120,000 does not exceed $160,000.

Time On Task: 12 minutes

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Chapter 17—Alternative Minimum Tax and Other Taxes End-of-Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.1 Solution: A taxpayer who must pay alternative minimum tax (AMT) also must pay the regular income tax.

If the tentative minimum tax (TMT) is greater than the regular tax, that difference is the AMT and the taxpayer must pay the AMT in addition to the regular tax.

Time on Task: 2 minutes 2) Title: Discussion Question 2 Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.1 Solution: Examples of AMT adjustments include: •

• • • • •

MACRS 3, 5, 7, and 10-year life property is depreciated using the 200% declining balance method for tax purposes. For AMT, the 150% declining balance method is used over the MACRS life with a half-year convention. This adjustment does not apply to property depreciated using bonus depreciation.

Gain or loss from property transactions.

Percentage of completion contract income over completed contract income.

Itemized deductions: No deduction is allowed for taxes for AMT. The standard deduction (if used) is added back.

The compensation element on the exercise date for an incentive stock option.

Examples of AMT preferences include: •

Tax-exempt interest on private activity bonds (PAB) except for: o Bonds issued after July 30, 2008, the PAB interest is not a preference if the bonds are for low-income housing developments, mortgage bonds, and mortgage bonds for veterans.

1

o

For any bond issued in 2009 and 2010, the interest earned on these bonds will not be included as AMT income.

• Qualifying small business stock gain exclusion (7% of the excluded gain) if the QSBS was purchased before September 28, 2010.

• Percentage depletion in excess of cost basis on certain mineral properties.

Time on Task: 5 minutes 3) Title: Discussion Question 3 Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.1 Solution: The AMT exemption is completely phased out if the taxpayer’s AMTI is greater than $1,751,900 for married filing jointly, $952,150 for unmarried, and $875,950 for married filing separately in 2024.

Time on Task: 2 minutes 4) Title: Discussion Question 4 Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.1 Solution: The AMT credit is created when the amount of AMT paid is due to timing differences between regular taxable income and AMTI. This AMT credit can be used to offset regular tax liability (but not below the tentative minimum tax for a given year) in future years. The AMT credit can be carried forward indefinitely.

Time on Task: 2 minutes 5) Title: Discussion Question 5 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.2 Solution:

2

The self-employment tax consists of the Social Security tax and the Medicare tax. The Social Security tax is 12.4% of the first $168,600 (2024) of self-employment income and the Medicare tax is 2.9% of all self-employment income (no ceiling).

Time on Task: 3 minutes 6) Title: Discussion Question 6 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.2 Solution: Per Rev. Rul. 87-41, 1987-1 CB 296, some factors used to determine an employee versus an independent contractor include: • Level of instruction provided to the worker.

• Amount of training provided.

• Continuity of relationship between the worker and the business.

• The worker’s flexibility in choosing when and where to work.

• The number of hours worked.

• Do oral or written reports need to be provided.

• Consistency of pay provided by the business.

• Payment of business expenses incurred by the worker but paid by the business.

Time on Task: 5 minutes 7) Title: Discussion Question 7 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.2 Solution: If Jane is a general partner in a partnership, she has to pay self-employment tax on her distributive share of partnership income and guaranteed payments for services (but not for use of capital) she receives from the partnership. The distributive share from a partnership or LLC is considered self-employment earnings if the partner is a material participant in the business.

Time on Task: 3 minutes 8) Title: Discussion Question 8 Difficulty: Medium Learning Objective 1: 17.2 3

Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.2 Solution: Net earnings from self-employment is generally the gross income from a trade or business reduced by any related business deductions (e.g., net income on Schedule C). It also generally includes the distributive share of partnership income and guaranteed payments from partnerships.

Time on Task: 3 minutes 9) Title: Discussion Question 9 Difficulty: Easy Learning Objective 1: 17.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.2 Solution: A self-employed person is allowed to deduct one-half of their self-employment tax as a deduction for AGI. Time on Task: 2 minutes 10) Title: Discussion Question 10 Difficulty: Medium Learning Objective 1: 17.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.3 Solution: Lazarus needs to consider nanny tax obligations for the babysitter. The babysitter is considered a domestic worker and an employee of Lazarus because Lazarus controls when she works and how the work is to be performed. The maid is not his employee because she is hired through an agency and is the agency’s employee.

Time on Task: 3 minutes 11) Title: Discussion Question 11 Difficulty: Medium Learning Objective 1: 17.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.3

4

Solution: The additional Medicare tax is an additional 0.9% tax that applies to wages and self-employment income in excess of $250,000 for joint filers, $125,000 for married filing separately, and $200,000 for single and head of household filers. The employer will withhold this tax if the employee’s pay is greater than $200,000 regardless of their filing status. Or, if the employee has earned income from more than one employer in excess of $200,000 (single), then the employee pays this tax with their Form 1040.

Time on Task: 4 minutes Multiple Choice Questions 1) Answer: b Title: Multiple Choice Question 1 Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.1 Solution: The correct answer is $103,000.

Brett calculates his AMTI before the exemption as follows: Taxable income Plus: Local taxes AMTI

$100,000 3,000 $103,000

Home mortgage interest and charitable contributions are not an AMT adjustment.

Time on Task: 4 minutes 2) Answer: d Title: Multiple Choice Question 2 Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.1 Solution: The correct answer is Taxpayers that do not have dividend income are not subject to the alternative minimum tax.

Taxpayers without dividend income may be subject to the AMT for different reasons. The other possible answers are true statements.

Time on Task: 3 minutes

5

3) Answer: b Title: Multiple Choice Question 3 Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.1 Solution: The correct answer is $1,500 AMT is the tentative minimum tax in excess of the regular tax, which is $1,500 ($13,500 − $12,000).

4) Answer: b Title: Multiple Choice Question 4 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.2 Solution: The correct answer is The self-employment tax is imposed only on individuals that operate a partnership as a general partner The self-employment tax is imposed on many types of income, including sole proprietorship income, partnership distributions, and royalties from business activities such as writing a book.

The other possible answers are true statements.

Time on Task: 3 minutes 5) Answer: c Title: Multiple Choice Question 5 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.2 Solution: The correct answer is $12,000.

An executor’s fee is not from a trade or business activity, so it is not self-employment income.

Director’s fees are self-employment income.

Time on Task: 2 minutes

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6) Answer: d Title: Multiple Choice Question 6 Difficulty: Easy Learning Objective 1: 17.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.2 Solution: The correct answer is $4,733.

The deduction for AGI for self-employment tax is calculated as follows, ($67,000  92.35%  15.3%)  50% = $4,733.

Time on Task: 2 minutes 7) Answer: c Title: Multiple Choice Question 7 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.2 Solution: The correct answer is Disability benefits.

Sick pay, vacation pay, and severance pay are all subject to federal income tax withholding.

Time on Task: 3 minutes 8) Answer: d Title: Multiple Choice Question 8 Difficulty: Medium Learning Objective 1: 17.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.3 Solution: The correct answer is Yard maintenance worker, babysitter, and butler.

Examples of household workers that can qualify for the nanny tax are babysitters, nannies, butlers, cooks, and sometimes, private tutors.

9) Answer: a

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Title: Multiple Choice Question 9 Difficulty: Easy Learning Objective 1: 17.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 17.3 Solution: The correct answer is 0.9%.

The additional Medicare tax percentage calculated on wages in excess of $250,000 for married filing jointly, $125,000 for married filing separately, and $200,000 for single and head of household filers is 0.9%.

Time on Task: 1 minute Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.1 Solution: The AMT exemption for a single filer in 2024 is $85,700 and this exemption begins to phase out once AMTI reaches $609,350 for 2024. Lynne’s allowable AMT exemption is: AMTI before exemption Threshold Excess Phase out rate Exemption phaseout Exemption available Less: Phaseout Exemption allowed Time on Task: 4 minutes

$625,000 ( 609,350) $ 15,650  25% $ 3,913 (rounded) $ 85,700 ( 3,913) $ 81,787

2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application

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Section Reference 1: 17.1 Solution: AMT is due when the tentative minimum tax exceeds the regular tax liability.

AMTI after the exemption AMT rate TMT Regular tax liability AMT

$188,000  26% $ 48,880 ($ 34,323)* $ 14,557

*From single tax rate schedule for 2024: $17,168.50 + [($172,000 − $100,525)  24%] Time on Task: 5 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.2 Solution: Tanner’s net earnings from self-employment is $70,000: Gross receipts Less: Cost of goods sold Less: Other operating expenses Net earnings from self-employment

$122,000 ( 38,000) ( 14,000) $ 70,000

The interest income is not self-employment income, and the self-employment tax is not deductible in calculating net earnings from self-employment Time on Task: 5 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.2 Solution: Amari must pay self-employment tax of $20,064 and can deduct one-half of the self-employment tax of $10,032 in calculating adjusted gross income, computed as follows: Net earnings from self-employment

$142,000

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 92.35%

Base earnings from self-employment tax Self-employment tax rate Self-employment tax

$131,137  15.3% $ 20,064

One-half of the self-employment tax is deducted for AGI ($20,064  50% = $10,032).

Time on Task: 5 minutes 5) Title: Brief Exercise 5 Difficulty: Medium Learning Objective 1: 17.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.3 Solution: Julius must withhold employment taxes of $956 ($12,500  7.65%) from the babysitter’s paycheck. Julius does not need to withhold any employment taxes for the yard maintenance worker because his earnings are less than $2,700 (2024). Julius must remit $1,912 ($956  2) to the IRS consisting of the withheld payroll taxes and his match.

Time on Task: 4 minutes 6) Title: Brief Exercise 6 Difficulty: Medium Learning Objective 1: 17.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.3 Solution: Fatima is subject to the additional Medicare tax because her total wages exceed $200,000 for a single filer. Fatima owes the additional Medicare tax of $342 [$133,000 + $105,000) − $200,000  0.9%].

Time on Task: 4 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application

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Section Reference 1: 17.1 Solution: Ruud has AMTI of $62,120 calculated as follows: Taxable income Plus: AMT adjustments: State tax refund Tax-exempt interest from PAB Property taxes AMTI before exemption Less: Exemption–Single AMTI after exemption

$142,000 ($ 880) 1,200 5,500

5,820 $147,820 ( 85,700) $ 62,120

The mortgage interest expense of $7,900 is deductible for both regular taxable income and AMT so an adjustment is not needed. The state income tax refund is not included in AMTI since the state income taxes were not deductible for AMT purposes in the year paid. The AMT exemption is not phased out because the AMTI before the exemption is below the phaseout range of $609,350 (2024).

Time on Task: 5 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.1 Solution: Almira and Malik have AMTI of $300,500 calculated as follows: Taxable income Plus: AMT adjustments: State income taxes paid Depreciation adjustment AMTI before exemption Less: Exemption–MFJ AMTI after exemption

$ 423,000 $9,000 1,800

10,800 $ 433,800 ( 133,300) $ 300,500

The charitable contributions paid of $4,100 are deductible for both regular taxable income and AMT so an adjustment is not needed. The regular tax depreciation of $6,500 exceeds the AMT depreciation of $4,700, so the difference of $1,800 must be added back to taxable income. The AMT exemption is not phased out because the AMTI before the exemption is below the phaseout range of $1,218,700 (2024).

Time on Task: 5 minutes

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3) Title: Application Problem 3 Difficulty: Hard Learning Objective 1: 17.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.1 Solution: Taxable income Plus: AMT adjustments Plus: AMT preferences AMTI before exemption Less: Exemption–Head of Household AMTI after exemption

$305,000 11,000 3,600 $319,600 ( 85,700) $233,900

Tentative minimum tax Less: Regular tax liability AMT

$ 60,840 75,432 $ 0

The AMT exemption is not phased out because the AMTI before the exemption is below the beginning of the phaseout range. You compute the tentative minimum tax at 26% on the first $232,600 of AMTI and 28% on the remainder. [($232,600  26%) + ($233,900 − $232,600)  28%] = $60,840 You calculate the regular tax liability using the head of household rates for 2024. $53,977 + ($305,000 − $243,700)  35% = $75,432.

Because the tentative minimum tax of $60,840 is less than the regular tax liability of $75,432, there is no AMT. Time on Task: 8 minutes 4) Title: Application Problem 4 Difficulty: Hard Learning Objective 1: 17.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.1 Solution: AMTI before exemption Less: Exemption–Single AMTI after exemption

$630,000 ( 80,537) $549,463

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Tentative minimum tax

$149,198

Raquel’s AMTI before the exemption is greater than the beginning of the phaseout range for a single filer; therefore, the exemption is partially phased out. The phaseout rate is 25% of the amount of AMTI over the beginning of the phaseout range. The phaseout is $5,163 [($630,000 − $609,350)  25%]. The allowable exemption is $80,537 ($85,700 − $5,163).

You calculate the tentative minimum tax as 26% on the first $232,600 of AMTI and 28% on the remainder. [($232,600  26%) + ($549,463 − $232,600)  28%] = $60,476 + $88,722 = $149,198 Time on Task: 8 minutes 5) Title: Application Problem 5 Difficulty: Hard Learning Objective 1: 17.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.1 Solution: Taxable income Less: AMT adjustments Plus: AMT preferences AMTI before exemption Less: Exemption–MFJ AMTI after exemption

$1,200,000 ( 13,000) 250,000 $1,437,000 ( 78,725) $1,358,275

Tentative minimum tax Regular tax liability AMT

$ 375,665 ( 370,126) $ 5,539

Cassidy and Chris’s AMTI before the exemption is greater than the beginning of the phaseout range for married filing joint filers; therefore, the exemption is partially phased out. The phaseout rate is 25% of the amount of AMTI over the beginning of the phaseout range. The phaseout is $54,575 [($1,437,000 − $1,218,700)  25%]. The allowable exemption is $78,725 ($133,300 − $54,575).

The tentative minimum tax is calculated at 26% on the first $232,600 of AMTI and 28% on the remainder. [($232,600  26%) + ($1,358,275 − $232,600) × 28%] = $60,476 + $315,189 = $375,665 You calculate the regular tax liability using the married filing joint rates for 2024. $196,669.50 + ($1,200,000 − $731,200) × 37% = $370,126.

The AMT is the difference between the tentative minimum tax and the regular tax liability, $5,539 ($375,665 − $370,126).

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Time on Task: 8 minutes 6) Title: Application Problem 6 Difficulty: Hard Learning Objective 1: 17.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.1 Solution: Taxable income Plus: AMT adjustments: Property taxes Plus: AMT preferences: 7% on QSBS exclusion $13,125 Percentage depletion over basis 17,000 AMTI before exemption Less: Exemption–MFJ AMTI after exemption Tentative minimum tax Regular tax liability AMT

$1,200,000 10,000

30,125 $1,240,125 ( 127,944) $1,112,181 $ 306,759 $ 370,126 $ 0

Patrick and Tamara’s property taxes were deductible for regular tax but only up to $10,000.

Because they cannot deduct property taxes for AMT, the taxes must be added back to taxable income. Mortgage interest expense is allowed for regular tax and AMT purposes, so no AMT adjustment is needed.

Because the couple purchased the stock after February 17, 2009, and before September 28, 2010, and they held the stock for more than five years, 75% of the gain is eligible for the Section 1202 QSBS exclusion from regular tax. Therefore, $62,500 (($350,000 − $100,000)  25%) of the gain is included in regular taxable income and $187,500 (($350,000 − $100,000)  75%) is excluded.

The amount of the excluded gain that they must include in AMT income is 7% of the excluded gain, or $13,125 (7%  $187,500).

The couple has an AMT preference of $17,000, the excess of the percentage depletion over the basis of the property ($47,000 − $30,000).

Patrick and Tamara’s AMTI before the exemption is greater than the beginning of the phaseout range for married filing joint filers; therefore, the exemption is partially phased out. The phaseout rate is 25% of the amount of AMTI over the beginning of the phaseout range. The phaseout is $5,356 [($1,240,125 − $1,218,700)  25%]. The allowable exemption is $127,944 ($133,300 − $5,356).

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You calculate the tentative minimum tax as 26% on the first $232,600 of AMTI and 28% on the remainder. [($232,600 × 26%) + ($1,112,181 − $232,600) × 28%] = $306,759 (rounded) You calculate the regular tax liability using the married filing joint rates for 2024. $196,669.50 + ($1,200,000 − $731,200) × 37% = $370,126 Because TMT is less than the regular tax liability, there is no AMT. The total tax liability is $370,126.

Time on Task: 8 minutes 7) Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.2 Solution: Desmond’s net earnings from self-employment is $80,000: Gross receipts Less: Operating expenses Net earnings from self-employment

$98,000 (18,000) $80,000

The dividend income and short-term capital gains are not self-employment income, and the selfemployment tax is not deductible in calculating net earnings. The charitable contributions paid are an itemized deduction on Schedule A and not deductible on Schedule C. Time on Task: 4 minutes 8) Title: Application Problem 8 Difficulty: Easy Learning Objective 1: 17.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.2 Solution: Emma’s wages are $12,300 and subject to Social Security tax of 6.2% and Medicare tax of 1.45%. Emma’s employer should withhold $941 ($12,300  7.65%).

Time on Task: 2 minutes 9) Title: Application Problem 9 Difficulty: Medium

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Learning Objective 1: 17.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.2 Solution: Jasmine must pay self-employment tax of $18,227 and can deduct one-half of the selfemployment tax, which is $9,114 ($18,227  50% = $9,114), in calculating adjusted gross income, computed as follows: Net earnings from self-employment

$129,000  0.9235 $119,132  0.153 $ 18,227

Actual net earnings Self-employment tax rate Self-employment tax Time on Task: 4 minutes

10) Title: Application Problem 10 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.2 Solution: Jasmine must pay self-employment tax of $29,717 and can deduct one-half of the selfemployment tax, which is $14,859, in calculating adjusted gross income, computed as follows: Net self-employment income

$329,000  0.9235 $303,832

Actual net earnings

The maximum amount subject to Social Security tax in 2024 is $168,600. Therefore, Jasmine has Social Security tax of $20,906 ($168,600  12.4%). Her Medicare tax is $8,811 ($303,832  2.9%). Her total self-employment taxes are $29,717 ($20,906 + $8,811). One-half of the selfemployment tax is deducted for AGI ($29,717  50% = $14,859).

Time on Task: 6 minutes 11) Title: Application Problem 11 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting

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Standard 3: Bloom's || Application Section Reference 1: 17.2 Solution: Yannick has paid Social Security tax on $175,000 ($105,000 + $70,000) of wages. The total Social Security tax withheld from his wages is $10,850 ($6,510 + $4,340). The maximum Social Security tax that Yannick should pay in 2024 is $10,453 ($168,600 × 6.2%). Yannick’s excess Social Security tax paid is $397 ($10,850 − $10,453). Yannick receives a credit of $397 on his Form 1040 for the excess Social Security tax paid which will reduce his federal income tax liability.

Time on Task: 5 minutes 12) Title: Application Problem 12 Difficulty: Hard Learning Objective 1: 17.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.2 Solution: The maximum amount of wages and self-employment income subject to Social Security tax in 2024 is $168,600. Grayson's Social Security tax withheld from his wages are $5,456 ($88,000 × 6.2%). Grayson's actual net earnings from self-employment are $132,984 ($144,000 × 92.35%).

His Social Security tax on actual net earnings from self-employment income is computed using the lesser of: 1) $132,984, or 2) $80,600 ($168,600 maximum − $88,000 wages).

Social Security tax from self-employment income is $9,994 ($80,600 × 12.4%). Therefore, total Social Security tax for Grayson is $15,450 ($5,456 + $9,994).

13) Title: Application Problem 13 Difficulty: Medium Learning Objective 1: 17.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.3 Solution: Shakira must withhold employment taxes for both the nanny and the tutor at 7.65% for each. $4,743 ($62,000  7.65%). She hired the maid through an employment agency, so she is considered an employee of the agency and not Shakira.

Time on Task: 3 minutes

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14) Title: Application Problem 14 Difficulty: Easy Learning Objective 1: 17.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.3 Solution: Dakota and Denka’s combined wages total $285,000 which exceeds the $250,000 threshold for married filing joint filers for the additional Medicare tax. They will owe $315 [($285,000 − $250,000)  0.9%].

Time on Task: 2 minutes 15) Title: Application Problem 15 Difficulty: Medium Learning Objective 1: 17.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.3 Solution: Jasmine owes $934 ($103,832  0.9%) of additional Medicare tax. Her base earnings from selfemployment income are $303,832 ($329,000 × 92.35%) which exceeds the threshold of $200,000 for a single filer. Therefore, $103,832 ($303,832 − $200,000) is subject to the additional Medicare tax.

Time on Task: 3 minutes 16) Title: Application Problem 16 Difficulty: Medium Learning Objective 1: 17.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 17.3 Solution: If Thao’s wages are $269,000, then $14,975 should be withheld, calculated as follows: Social Security tax ($168,600 × 6.2%) Medicare tax ($269,000 × 1.45%) Additional Medicare tax ($269,000 − $200,000) × 0.9% Total withheld

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$10,453 3,901 621 $14,975

Tax Planning Problem 1) Title: Tax Planning Problem 1 Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 17.2 Solution: Petra will owe less overall tax if she chooses to be a shareholder in the S corporation. Based only on the information provided, Petra will not have to pay self-employment tax on the S corporation income, but she would have to pay self-employment tax on her share of partnership income if she were a general partner who is actively involved in the business activities.

Time on Task: 5 minutes Communication Problem 1) Title: Communication Problem: Alternative Minimum Tax Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 17.1 Solution: Memo to Client Hello Franco and Marisol, I enjoyed meeting with you last week to discuss reviewing your previous two years’ tax returns.

This letter follows up that conversation.

Your last two tax returns are correct as filed. When you invested in the construction partnership two years ago, you began receiving a Schedule K-1, which shows your distributive share of income and other items flowing from the partnership. Some of the other items are alternative minimum tax adjustments and preferences. The alternative minimum tax is a separate but parallel system that calculates a broader tax base by modifying taxable income for individuals. These modifications generally serve to increase taxable income by adding items of income not recognized by regular tax and disallowing deductions that do not necessarily represent economic outlays. A tentative minimum tax (TMT) is calculated and compared with your regular tax

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liability. In your case, your TMT was greater than the regular tax liability calculated. Because of this, you owed AMT, and this increased your overall tax liability.

Please let me know if you need further clarification on this issue or any other tax matter that you might have.

Sincerely, Carnes & Youngberg, CPAs Memo to the tax file Facts: Franco and Marisol Diego are concerned that they have overpaid their taxes for the last two years. They invested in a construction partnership two years ago that generated substantial AMT adjustments and preferences.

Issue: Did the Diegos overpay their tax liability for the last two years?

Conclusion: No, the Diegos did not overpay their tax liability and the tax returns are correct as filed.

Analysis: IRC §55 describes the alternative minimum tax and how it is calculated. AMT positive adjustments and preferences increase taxable income to arrive at AMTI. Tentative minimum tax (TMT) is calculated at either 26% or 26%/28%. If the taxpayer’s TMT is greater than the regular tax liability, then the taxpayer will owe AMT and pay the total TMT. In the Diegos' situation, the AMT adjustments and preferences were quite large and created a large TMT. After reviewing the partnership Schedule K-1s and Form 6251 for the last two years, it appears the Diegos' overall tax liability is correct.

Time on Task: 15 minutes Ethics Problem 1) Title: Ethics Problem: Nanny Tax Difficulty: Medium Learning Objective 1: 17.3 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 17.3 Solution: Based on the information provided, Kourtney should pay employment taxes on the money earned by both workers, because they are household employees. Kourtney has the responsibility of withholding employment taxes from the worker’s pay each pay period and then reporting and paying the taxes with Kourtney’s individual income tax return. If the wages are high enough, she may have to report and pay the taxes quarterly.

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Your responsibility as her tax accountant is to make sure you file her returns accurately. Under SSTS No. 1.2.6, "A member should promptly inform a taxpayer upon becoming aware of the taxpayer’s failure to file a required return, [or] an error in a previously filed return [...]" Under Circular 230, §10.21 Knowledge of Client’s Omission, you must inform Kourtney of the omission on the previous year’s returns, and under Circular 230, §10.22 Diligence as to Accuracy, you have the responsibility to prepare the tax return accurately. Also, under SSTS No. 1.2 : Knowledge of Errors, the preparer should follow "the applicable standards [whenever they] [...] become aware of an error in a taxpayer’s previously filed tax return."

Time on Task: 10 minutes Research Problems 1) Title: Research Problem 1: Effect of AMT on Individuals Difficulty: Difficult Learning Objective 1: 17.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 17.1 Solution: The number of returns and amount of AMT reported decreased sharply in 2018 with only 244,007 returns reporting AMT with a total amount of $4,022,755, compared to 5,075,419 returns reporting AMT with a total amount of $36,404,112 in 2017. By 2020, the number of impacted taxpayers decreased to approximately $156,000. Because the TCJA is due to expire in 2025, we can expect that the pre-2018 returns and amounts will return in 2026 if Congress does not extend the current law concerning AMT. Time on Task: 8 minutes 2) Title: Research Problem 2: Reporting of Income Difficulty: Difficult Learning Objective 1: 17.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 17.2 Solution: The tax law considers driving for Uber as gig work. The gig economy—also called sharing economy or access economy—is an activity where people earn income providing on-demand work, services, or goods. Often, it is through a digital platform like an app or website. Per the IRS Gig Economy Tax Center, driving a car for booked rides or deliveries is gig work.

Charmaine will report the $3,800 earned as an Uber driver on Schedule C, Profit of Loss From Business (Sole Proprietorship). She must also report any income or tips received that were not reported on Form 1099-K. She can take a deduction for the miles driven in her car for business use at 67 cents per mile (2024). Charmaine needs to keep a mileage log to prove the miles driven

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for business. Also, if she incurred any fees, commissions, or phone rental payments, or other expenses, then she can take a deduction for the business portion of the expense. The net earnings from self-employment will be subject to self-employment tax on Schedule SE. Time on Task: 5 minutes Excel Problem 1) Title: Excel Problem: Calculating Total Tax Liability Difficulty: Medium Learning Objective 1: 17.1 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 17.1 Solution: [[COMP: See file "Carnes_I2025_Ch17_SM_Excel Problem Solution 2024.xlsx"]] Situation 1 Formula for computing AMT: Regular taxable income Plus/Less: Adjustments Plus: Preferences AMT income before exemption Less: Exemption–MFJ AMT base  AMT rate Tentative minimum tax (TMT) Less: Regular tax liability AMT (if positive)

$185,000 ( 10,000) 8,000 $183,000 ( 133,300) $ 49,700 26% $ 12,922 ( 30,806) $ 0

Situation 2 Formula for computing AMT: Regular taxable income Plus/Less: Adjustments Plus: Preferences AMT income before exemption Less: Exemption–MFJ AMT base  AMT rate Tentative minimum tax (TMT)

$250,000 40,000 22,000 $312,000 ( 133,300) $178,700 26% $ 46,462

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Less: Regular tax liability AMT (if positive)

( 46,085) $ 377

Situation 3 Formula for computing AMT: Regular taxable income Plus/Less: Adjustments Plus: Preferences AMT income before exemption Less: Exemption–MFJ AMT base  AMT rate Tentative minimum tax (TMT) Less: Regular tax liability AMT (if positive)

$ 1,000,000 135,000 175,000 $ 1,310,000 ( 110,475)* $ 1,199,525 26%, 28% $ 331,215 ( 296,126) $ 35,089

*$110,475 [$133,300 − ($1,310,000 − $1,218,700)  25%)] Time on Task: 15 minutes

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Input Area: Taxable Income Adjustments Preferences

1,000,000 135,000 175,000

Calculation: AMT Income before Exemption Exemption AMT Base AMT Rate Tentative Minimum Tax Regular Tax Liability AMT (if positive)

1,310,000 (110,475) 1,199,525 27.61% 331,215 (296,126) 35,089

AMT Exemption Phaseout AMT Exemption Threshold Phaseout Amount Complete Phaseout Amount

133,300 1,218,700 1,751,900

AMT Rate AMTI 232,600 MFJ Income Tax Brackets 23,200 94,300 201,050 383,900 487,450 731,200

26% 28% Times

Plus 10% 12% 2,320 22% 10,852 24% 34,337 32% 78,221 35% 111,357 37% 196,669.50

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CPA Exam Preparation: Task-Based Simulations 1) Title: Task-Based Simulation: Schedule SE Difficulty: Medium Learning Objective 1: 17.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 17.2 Solution: Schedule SE 1. Determine Salty Salmon’s net profit to be reported on Schedule C. 2. Calculate Fisher Bass’ self-employment tax. A blank Schedule SE has been provided as reference.

$139,200 $19,668

Rationale: 1. Salty Salmon’s net profit is $139,200.

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Revenue: Charter revenue Fish preparation revenue Total revenue Expenses: Advertising Fuel Repairs and maintenance Wages paid Insurance Supplies Depreciation Total expenses Net profit

$332,000 78,000 $410,000

$ 12,000 100,000 26,000 62,000 24,000 1,800 45,000 ($270,800) $139,200

Interest income is reported separately on Schedule B, Interest and Dividends. Charitable contributions are reported separately on Schedule A, Itemized Deductions. The docking fines are not deductible.

2. Fisher’s self-employment tax is $19,668.

Net earnings from self-employment Reduction Actual net earnings Self-employment tax rate Self-employment tax

$139,200 × 92.35% $128,551 × 15.3% $ 19,668

Because Fisher’s actual net earnings are less than $168,600, he is taxed at 15.3%.

Time on Task: 12 minutes 2) Title: Task-Based Simulation: Employment Taxes Difficulty: Hard Learning Objective 1: 17.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 17.2 Solution: Employment Taxes 1. Determine SWC’s total taxes to be remitted $46,625 to the federal government in regard to Ellie’s employment.

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2. What is Ellie’s net pay from her paychecks $87,937 for 2024 after reducing for all taxes withheld?

3. If Ellie’s salary is $170,000 and federal $61,836 income tax withheld is $36,000, determine SWC’s total taxes to be remitted to the federal government in regard to Ellie’s employment.

4. If Ellie’s salary is $170,000 and federal $121,082 income tax withheld is $36,000, what is Ellie’s net pay from her paychecks for 2024 after reducing for all taxes withheld?

Rationale 1. Determine SWC’s total taxes to be remitted to the federal government in regard to Ellie’s employment.

Social Security tax (6.2%  2  $125,000) Medicare tax (1.45%  2  $125,000) Federal income tax withheld Total taxes to be remitted

$15,500 3,625 27,500 $46,625

SWC must remit the federal income tax withheld, the employee portion of employment taxes collected, and the employer portion of employment taxes owed.

2. What is Ellie’s net pay from her paychecks for 2024 after reducing for all taxes withheld?

Gross Salary Social Security tax (6.2%  1  $125,000) Medicare tax (1.45%  1  $125,000) Federal income tax withheld Net pay

$ 125,000 ( 7,750) ( 1,813) ( 27,500) $ 87,937

Federal unemployment tax is the employer’s responsibility, so this does not affect Ellie’s net pay.

3. If Ellie’s salary is $170,000 and federal income tax withheld is $36,000, determine SWC’s total taxes to be remitted to the federal government in regard to Ellie’s employment.

Social Security tax (6.2%  2  $168,600) Medicare tax (1.45%  2  $170,000) Federal income tax withheld Total taxes to be remitted

$20,906 (rounded) 4,930 36,000 $61,836

SWC must remit the federal income tax withheld, the employee portion of employment taxes collected, and the employer portion of employment taxes owed. However, Social Security tax is

27

only collected and paid on the first $168,600 in 2024. Medicare tax is collected and paid on Ellie’s full salary.

4. If Ellie’s salary is $170,000 and federal income tax withheld is $36,000, what is Ellie’s net pay from her paychecks for 2024 after reducing for all taxes withheld?

Gross Salary Social Security tax (6.2%  1  $168,600) Medicare tax (1.45%  1  $170,000) Federal income tax withheld Net pay

$170,000 ( 10,453) ( 2,465) ( 36,000) $121,082

Social Security tax is only collected and paid on the first $168,600 in 2024.

Time on Task: 15 minutes

28

Chapter 18—Business Entity Topics End-of-Chapter Solutions Discussion Questions 1) Title: Discussion Question 1 Difficulty: Easy Learning Objective 1: 18.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.1 Solution: The general rules for income and deductions for individuals are the starting point for computing corporate taxable income. For example, the following rules for income are the same for individuals and for corporations: • • • •

Income will be taxable if the taxpayer’s wealth has increased, the taxpayer has realized this increase in wealth, and the law does not provide a specific exclusion for this type of income.

Prepaid revenue is generally included in income when received, even for accrual-basis taxpayers.

Municipal interest income is exempt from taxation.

Long-term capital gains are gains from the sale of capital assets held for more than one year.

Similarly, the basic rules for income and deductions are the same for individuals and corporations: •

Business expenses are deductible if they are incurred in operating a business and are ordinary, necessary, and reasonable.

• Expenditures that are a violation of public polity are not deductible.

• Prepaid interest expense is deducted over the period the interest relates to, not when paid, even for cash-basis taxpayers.

• Net operating losses are generated only by business losses and casualty losses.

Time on Task: 6 minutes 2) Title: Discussion Question 2 Difficulty: Easy Learning Objective 1: 18.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.1

Solution: Cash-basis corporations deduct charitable contributions in the year that they pay the contribution.

An accrual-basis corporation can elect to deduct accrued contributions if the corporation’s board has approved the contribution before year-end, and it has been paid within the first 3 ½ months following its year-end.

Time on Task: 2 minutes 3) Title: Discussion Question 3 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.1 Solution: All charitable contributions are not deducted based on the fair market value of the asset. Cash contributions are deductible based on the amount of cash given. For contributions of property, there are different rules for long-term capital gain property (LTCG) and all other property. The full fair market value (FMV) of contributions of LTCG property is deductible. For all other property, the deduction is: (FMV of the property) − (The ordinary income or short-term capital gain that would be recognized if the taxpayer sold the property)

A corporation's contribution of inventory or depreciable property or real property used in its trade or business can result in a deduction that is greater than the property’s adjusted basis.

Time on Task: 4 minutes 4) Title: Discussion Question 4 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.1 Solution: Congress allows the dividend received deduction to help mitigate triple taxation that could occur when dividends are paid to corporate shareholders.

Time on Task: 2 minutes 5) Title: Discussion Question 5 Difficulty: Medium Learning Objective 1: 18.1, 2

Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.1, 2 Solution: There are several important differences in the computation of income and deductions for corporations.

• Charitable contributions to qualified organizations are allowed but only to the extent of 10% of taxable income before the charitable contribution and the dividend received deduction.

• The dividend received deduction is allowed for corporate taxpayers.

• Corporations cannot deduct up to $3,000 of net capital losses, as individuals can.

Corporations can only use capital losses to offset capital gains. Capital losses cannot offset ordinary income. Any unused capital loss is carried back three years and carried forward five years.

Time on Task: 4 minutes 6) Title: Discussion Question 6 Difficulty: Easy Learning Objective 1: 18.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.2 Solution: Corporations do no not have a preferential tax rate for LTCGs. Rather, ordinary income, STCGs, and LTCGs are taxed at the same tax rate, 21%.

Time on Task: 2 minutes 7) Title: Discussion Question 7 Difficulty: Easy Learning Objective 1: 18.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.2 Solution: C corporations can designate any month for its year-end. While many corporations have a calendar year-end, this is not required. However, S corporations are generally required to use a calendar year Time on Task: 2 minutes 8) Title: Discussion Question 8

Difficulty: Easy Learning Objective 1: 18.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.2 Solution: Corporations must use the accrual method of accounting unless the entity qualifies as a small business corporation. To be a small corporation, the corporation’s average gross receipts over the last three tax years cannot exceed $30 million (2024).

Time on Task: 2 minutes 9) Title: Discussion Question 9 Difficulty: Medium Learning Objective 1: 18.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.2 Solution: Corporations must comply with different reporting rules for tax purposes and for GAAP (generally accepted accounting principles).

• Expenses deducted for book income that are not deductible for taxable income: o Federal tax expense o Net capital losses o Charitable contributions that exceed the 10% of taxable income limit o Entertainment expenses o 50% of meals o Life insurance premiums on the lives of key employees o Fines, penalties, and other expenses in violation of public policy • Income not included in book income that is included in taxable income: o Prepaid income • Income included in book income that is not included in taxable income: o Municipal interest income o Life insurance proceeds due to death of the insured • Expenses not deducted for book income that are deducted for taxable income: o Tax depreciation in excess of book depreciation, including Section 179 expense and bonus depreciation. o Charitable contributions carried forward from a previous year.

Time on Task: 6 minutes 10) Title: Discussion Question 10 Difficulty: Medium Learning Objective 1: 18.2

Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.2 Solution: Taxpayers cannot carry back NOLs incurred after 2020. The taxpayer can carry them forward indefinitely, and they can offset only 80% of the taxable income for the year the NOL is used.

Time on Task: 3 minutes 11) Title: Discussion Question 11 Difficulty: Medium Learning Objective 1: 18.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.2 Solution: If Sharp Corporation had a net operating loss of $44,000 in 2020, Sharp can carry back the loss five years to 2015.

Time on Task: 2 minutes 12) Title: Discussion Question 12 Difficulty: Medium Learning Objective 1: 18.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.3 Solution: The United States includes income from all sources in taxable income, including income from foreign countries. Because income earned in a foreign country may also be taxed in that country, the purpose of the foreign tax credit is to mitigate the double taxation of that income. The credit is limited to the lower of: 1. Foreign tax paid, or 2. U. S. tax on worldwide income × Time on Task: 4 minutes 13) Title: Discussion Question 13 Difficulty: Medium Learning Objective 1: 18.3 Standard 1: AACSB || Knowledge

Foreign source taxable income Worldwide taxable income

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.3 Solution: The general business credit consists of a combination of credits designed to subsidize certain activities. While each credit is calculated independently, the combination of credits is subject to an overall limit. Unused credits are carried back one year and then forward 20 years. The general business credit is computed on Form 3800, General Business Credit. There are over 30 tax credits that make up the general business credit, each having its own rules. The general business credit is the sum of the individual credits that make it up, subject to a limitation.

The formula for the general business credit limitation is as follows: Taxpayer's net income tax – [(Net regular tax liability − $25,000) × 25%] Time on Task: 5 minutes 14) Title: Discussion Question 14 Difficulty: Medium Learning Objective 1: 18.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.3 Solution: The business energy credit is comprised of numerous credits with various percentages ranging generally from 10% to 30% for property such as: • Qualified fuel cell property • Solar energy equipment property • Qualified small wind energy property • Waste energy recovery property • Geothermal property • Qualified microturbine property • Combined heat and power system property • Geothermal heat systems property Time on Task: 4 minutes 15) Title: Discussion Question 15 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.4 Solution:

S corporations are legally incorporated under state law in the same manner as regular C corporations. Once incorporated, the shareholders elect to be taxed as an S corporation by filing Form 2553. The major tax advantage for S corporations as compared to C corporations is that S corporations have single taxation, contrasted with double taxation for C corporations. S corporation income is reported on Form 1120-S, U.S. Income Tax Return for an S Corporation, but the S corporation does not pay tax on this income. Rather, the income flows to the S corporation shareholders, regardless of whether it has been distributed, and the shareholders pay tax on the income on their returns. S corporations also have the following characteristics: • Shareholders have limited liability and are not liable for corporate debt.

• The adjusted basis of shareholders’ stock is adjusted each year for the shareholder’s share of income and losses as reported on Schedule K-1.

• Shareholders do not recognize income when they receive distributions to the extent that the fair market value of the distribution does not exceed their adjusted stock basis.

• Shareholders who work for the S corporation are employees who are subject to payroll taxes (Social Security and Medicare). However, the distributive share to shareholders is not subject to self-employment taxes.

Time on Task: 6 minutes 16) Title: Discussion Question 16 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4 Solution: PIC Corporation must file their S corporation election within 2 ½ months after the start of the new year. Therefore, PIC Corporation must file their election by March 15 of Year 11.

Time on Task: 3 minutes 17) Title: Discussion Question 17 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.4 Solution: While S corporation income flows through to shareholders and is taxed to them, there are three taxes that an S corporation could potentially be liable for on its Form 1120-S. These three taxes impact only S corporations that were previously C corporations. An S corporation might owe the built-in gains tax, the passive investment income tax, or the LIFO recapture tax.

Time on Task: 3 minutes

18) Title: Discussion Question 15 Difficulty: Easy Learning Objective 1: 18.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.5 Solution: A partnership is an association of two or more taxpayers to operate a business that has an objective to make a profit and is not taxed as a corporation. Partnership income is reported on Form 1065, U.S. Return of Partnership Income, but the partnership does not pay tax on this income.

Time on Task: 2 minutes 19) Title: Discussion Question 19 Difficulty: Medium Learning Objective 1: 18.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.5 Solution: Partnerships are referred to as pass-through entities because the entity-level income flows to the owners and is taxed only once on the owners’ returns. Distributions reduce the partners' basis in the partnership but are not taxed unless the cash distributed is greater than the partner’s basis in their partnership interest. The partner will be taxed on the ordinary business income of $45,000 and not on the distribution of $55,000, because the distribution does exceed the partner’s basis in their partnership interest.

Time on Task: 3 minutes 20) Title: Discussion Question 20 Difficulty: Medium Learning Objective 1: 18.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.5 Solution: Nonrecourse debt is debt for which no partner, or a person related to a partner, has the potential for an economic risk of loss. If the partnership does not pay back the nonrecourse debt, the lender’s only recourse is to take the property back that was secured by the debt.

Time on Task: 2 minutes

21) Title: Discussion Question 21 Difficulty: Easy Learning Objective 1: 18.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.6 Solution: To qualify as an exempt organization the organization must operate exclusively for a tax-exempt purpose. The most common tax-exempt purposes are religious, charitable, scientific, literary, or educational purposes; prevention of cruelty to children or animals; or promoting amateur sports activities. Influencing legislation or political parties is not an acceptable purpose.

Time on Task: 2 minutes Multiple Choice Questions 1) Answer: c Title: Multiple Choice Question 1 Difficulty: Easy Learning Objective 1: 18.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.1 Solution: The correct answer is 21%.

Corporations are subject to a flat 21% tax rate.

Time on Task: 1 minute 2) Answer: d Title: Multiple Choice Question 2 Difficulty: Easy Learning Objective 1: 18.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.1 Solution: The correct answer is Proportionate (flat).

Corporations are subject to a flat 21% tax rate.

Time on Task: 1 minute 3)

Answer: a Title: Multiple Choice Question 3 Difficulty: Easy Learning Objective 1: 18.1 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.1 Solution: The correct answer is Form 1120.

Corporations report their taxable income or loss on Form 1120, page 1.

Time on Task: 1 minute 4) Answer: c Title: Multiple Choice Question 4 Difficulty: Easy Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: The correct answer is $4,500.

Cash-basis corporations deduct charitable contributions in the year that the contribution is paid.

Time on Task: 2 minutes 5) Answer: b Title: Multiple Choice Question 5 Difficulty: Easy Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: The correct answer is $42,500.

The limitation on the charitable contribution deduction is 10% of taxable income before the charitable contribution. Because 10% of taxable income before the charitable contribution equals $42,500 ($425,000 × 10%), only $42,500 of the contribution is deductible. Greco can carry forward the remaining $7,500 for five years.

Time on Task: 3 minutes 6) Answer: c

Title: Multiple Choice Question 6 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: The correct answer is $22,750.

If the ownership interest in a dividend-paying corporation is at least 20% and less than 80%, then the dividends-received deduction (DRD) percentage is 65%. The DRD for Sailor Inc. is $22,750 ($35,000  65%). The taxable income limitation is $81,250 (65% × $125,000), so this limit does not reduce the $22,750 deduction.

Time on Task: 3 minutes 7) Answer: c Title: Multiple Choice Question 7 Difficulty: Medium Learning Objective 1: 18.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.2 Solution: The correct answer is $109,600.

Birdie must first calculate its net capital gain or loss. By netting the short-term capital gains and losses and the long-term capital gains and losses, Birdie has a net capital gain of $9,600. This must be added to its taxable income before the capital transactions of $100,000 creating a taxable income after capital transactions of $109,600.

Time on Task: 3 minutes 8) Answer: d Title: Multiple Choice Question 8 Difficulty: Easy Learning Objective 1: 18.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.2 Solution: The correct answer is All of these.

Corporations can designate any month for its year-end. While many corporations have a calendar year-end, this is not required.

9) Answer: b Title: Multiple Choice Question 9 Difficulty: Easy Learning Objective 1: 18.2 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.2 Solution: The correct answer is Schedule M-3.

Corporations with total assets of $10 million or more must file Schedule M-3 instead of Schedule M-1.

Time on Task: 1 minutes 10) Answer: b Title: Multiple Choice Question 10 Difficulty: Medium Learning Objective 1: 18.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.2 Solution: The correct answer is $6,000.

Taxpayers cannot carry back NOLs incurred after 2020. The taxpayer can carry them forward indefinitely and they can offset only 80% of the taxable income for the year the NOL is used.

Because Raven's Inc. has taxable income of $30,000 in 2025, the NOL deduction is limited to 80% of taxable income, $24,000 ($30,000  80%). The NOL reduces Raven's Inc. taxable income to $6,000 ($30,000 − $24,000). The remaining $2,000 ($26,000 − $24,000) of the 2024 NOL is carried forward indefinitely.

Time on Task: 3 minutes 11) Answer: d Title: Multiple Choice Question 11 Difficulty: Easy Learning Objective 1: 18.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.3 Solution: The correct answer is Form 3800.

The general business credit is computed on Form 3800, General Business Credit.

Time on Task: 1 minute 12) Answer: d Title: Multiple Choice Question 12 Difficulty: Easy Learning Objective 1: 18.3 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.3 Solution: The correct answer is $150,000.

The maximum employer-provided childcare credit is $150,000 per year.

Time on Task: 1 minute 13) Answer: a Title: Multiple Choice Question 13 Difficulty: Easy Learning Objective 1: 18.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.4 Solution: The correct answer is 100.

The number of shareholders is limited to 100. However, more than 100 individuals can invest in an S corporation because husbands and wives are treated as one shareholder, and all members of a family and their estates are treated as a single shareholder.

Time on Task: 2 minutes 14) Answer: a Title: Multiple Choice Question 14 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.4 Solution: The correct answer is Issuing both common and preferred stock.

An S corporation can only have one class of stock. Preferred stock offers preferential distribution rights. S corporation shareholders must have distribution rights based on their stock ownership percentage

Time on Task: 2 minutes 15) Answer: a Title: Multiple Choice Question 15 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.4 Solution: The correct answer is Shareholders have unlimited liability.

S corporations are legally incorporated under state law in the same manner as regular C corporations. Shareholders have limited liability and are not liable for corporate debt.

Time on Task: 2 minutes 16) Answer: c Title: Multiple Choice Question 16 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4 Solution: The correct answer is 5,000 shares of voting stock and 5,000 shares of nonvoting stock.

In order for a revocation to be effective, there must be consent from more than 50% of the shareholders, including non-voting shareholders. Therefore, the S corporation needs consent from shareholders owning more than 9,000 shares [50% × (10,000 + 8,000)].

Time on Task: 2 minutes 17) Answer: d Title: Multiple Choice Question 17 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.4 Solution: The correct answer is Gross receipts from sales.

Gross receipts from sales are included in computing ordinary business income and is not separately stated. Interest income, dividend income, and capital gains are all separately stated

and reported on Schedule K of Form 1120-S. Each of these items flow through separately to the shareholders.

Time on Task: 2 minutes 18) Answer: c Title: Multiple Choice Question 18 Difficulty: Medium Learning Objective 1: 18.5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.5 Solution: The correct answer is Under the check-the-box regulations, entities that are incorporated may elect to be taxed as a partnership.

"Under the check-the-box regulations, entities that are incorporated may elect to be taxed as a partnership." is false because if an entity is incorporated then it must be treated as a corporation.

"A limited partner cannot actively manage the business of the partnership." is true because limited partners cannot actively manage the business. "Under the check-the-box regulations, limited liability companies generally are ‘disregarded’ if they have one owner." is true because if an LLC has one member, it is a single member LLC (SMLLC) and the entity is considered to be a disregarded entity for tax filing purposes. "Limited liability company owners are referred to as members." is true because LLC owners are referred to as members.

Time on Task: 2 minutes 19) Answer: a Title: Multiple Choice Question 19 Difficulty: Medium Learning Objective 1: 18.4, 5 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.4, 5 Solution: The correct answer is A general partner must pay self-employment tax on their share of ordinary business income.

General partners' distributive shares are subject to the self-employment tax, whereas limited partners' shares usually are not. Guaranteed payments for services rendered (not for use of capital) for both general and limited partners are subject to the self-employment tax.

Time on Task: 3 minutes 20) Answer: c Title: Multiple Choice Question 20

Difficulty: Easy Learning Objective 1: 18.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.6 Solution: The correct answer is $50,000.

Exempt organizations must file an information return, Form 990, Return of Organization Exempt from Tax, if gross receipts exceed $50,000.

Time on Task: 1 minute Brief Exercises 1) Title: Brief Exercise 1 Difficulty: Easy Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: Sparty Corporation has taxable income of $166,000 and the corporate tax rate is 21%. Sparty’s tax liability is $34,860 ($166,000  21%).

Time on Task: 2 minutes 2) Title: Brief Exercise 2 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: Twizzlers taxable income is $205,200.

Gross receipts Interest income Cost of goods sold Operating expenses Taxable income before NOL carryforward NOL carryforward Taxable income

$590,000 2,200 (135,000) (240,000) $217,200 ( 12,000) $205,200

The NOL carryforward is not limited because it is less than 80% of taxable income before the carryforward ($217,200 × 80% = 173,760).

Time on Task: 5 minutes 3) Title: Brief Exercise 3 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: Tiger Inc. can deduct $10,300 ($6,500 + $3,800). An accrual-basis corporation can elect to deduct accrued contributions if the corporation’s board has approved the contribution before year-end, and the corporation has paid it within the first 3½ months following the year-end. Tiger Inc. is allowed to deduct the charitable contribution of $6,500 on December 10 of the current year, and $3,800 on February 2 of the following year. The payment made on February 2 is within 3½ months of Tiger’s year end. The payment of $5,250 made on April 27 of the following year will be deductible in the following year.

Time on Task: 5 minutes 4) Title: Brief Exercise 4 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: Cyber Security Systems Inc (CSSI) can deduct a charitable contribution of $6,350 ($2,750 + $1,000 + $2,600). The full fair market value (FMV) of contributions of LTCG property is deductible.

Time on Task: 3 minutes 5) Title: Brief Exercise 5 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution:

Tasma Inc. can deduct a charitable contribution of $80,500. The allowable charitable contribution deduction is limited to 10% of taxable income computed before the charitable contribution deduction.

Net income after the charitable contribution $620,000 Plus: Charitable contributions 185,000 Net income before charitable contribution $805,000 Limitation  10% Deductible contribution $ 80,500 The remaining contribution of $104,500 ($185,000 − $80,500) is carried forward for up to five years.

Time on Task: 5 minutes 6) Title: Brief Exercise 6 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: Dolphins Inc. will have a dividends received deduction (DRD) of $6,000 ($12,000  50%).

Because ownership of the dividend paying corporation was less than 20%, Dolphins Inc. has a DRD percentage of 50% and a DRD of $6,000. Dolphins Inc must calculate their taxable income to see if the taxable income limitation will apply.

Gross receipts $100,000 Plus: Dividend income 12,000 Less: Cost of goods sold ( 33,000) Less: Operating expenses (35,000) Taxable income before DRD $ 44,000 Because the full DRD of $6,000 would not create a taxable loss ($44,000 − $6,000 = $38,000), the taxable income limitation does apply. The taxable income limit is $22,000 (50%  $44,000), which is greater than the DRD of $6,000, so the DRD is $6,000. Dolphins' taxable income is $38,000.

Taxable income before DRD Less: DRD Taxable income Time on Task: 7 minutes 7) Title: Brief Exercise 7 Difficulty: Medium Learning Objective 1: 18.2

$44,000 ( 6,000) $38,000

Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.2 Solution: Eagle Inc’s taxable income will remain at $100,000. Eagle must first calculate its net capital gain or loss. By netting the short-term capital gains and losses and the long-term capital gains and losses, Eagle has a net capital loss of $3,400 ($10,000 − $6,400 + $8,000 − $15,000). This loss is not currently deductible against the taxable income of $100,000 because corporations can offset capital losses only against capital gains. The net capital loss of $3,400 is carried back three years and carried forward five years.

Time on Task: 4 minutes 8) Title: Brief Exercise 8 Difficulty: Medium Learning Objective 1: 18.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.2 Solution: Gold Star’s taxable income is $263,900. Gold Star Inc. must make adjustments for items that are treated differently for book reporting versus tax reporting. Municipal interest income is not included in income for tax purposes and must be subtracted from book income. Entertainment expenses are not deductible for tax purposes and must be added back to book income. Charitable contribution carryforwards are allowed for tax purposes and must be subtracted from book income to arrive at taxable income. The charitable contribution carryforward does not exceed the 10% of income limitation, so the full amount can be deducted.

Book income Less: Municipal interest income Plus: Entertainment expenses Less: Charitable carryforward Taxable income Time on Task: 5 minutes 9) Title: Brief Exercise 9 Difficulty: Medium Learning Objective 1: 18.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.2 Solution:

$267,000 (1,400) 2,200 (3,900) $263,900

An NOL incurred in 2024 is not eligible to be carried back, so there is no tax savings from a carry back. The NOL can be carried forward indefinitely.

Time on Task: 4 minutes 10) Title: Brief Exercise 10 Difficulty: Medium Learning Objective 1: 18.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.3 Solution: Stormcast is not an eligible small business for purposes of the disabled access credit because it had gross receipts of more than $1,000,000 in the previous year. The basis of the building is increased by $5,500.

Time on Task: 3 minutes 11) Title: Brief Exercise 11 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4 Solution: Kate’s basis in her stock remains at $40,000. Kate cannot increase her basis for loans incurred by the S corporation because shareholders have limited liability. The lender cannot require payment of the loan from the owner of the corporation.

Time on Task: 2 minutes 12) Title: Brief Exercise 12 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4 Solution: At the beginning of the year, Fulmer's basis in their stock in Roadhouse was $50,000. Fulmer owns 50% so all items that affect basis must be multiplied by 50% before being added to beginning basis. The shareholder's share of income, including tax-exempt income, increases the shareholder's adjusted basis in their stock. The shareholder's share of loss (including

nondeductible expenses) decreases the shareholder's adjusted basis in their stock. Fulmer’s basis in their stock is calculated as follows: Beginning basis Municipal interest income Section 1231 gain Dividend income Basis available Less: Ordinary loss Ending basis Time on Task: 6 minutes

$50,000 2,000 3,000 4,000 $59,000 (10,000) $49,000

($4,000 × 50%) ($6,000 × 50%) ($8,000 × 50%) ($20,000 × 50%)

13) Title: Brief Exercise 13 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4 Solution: Aisha’s income allocation is $119,443 ($106,608 + $12,835), computed as follows: Amount reported on Form 1120-S × Stock ownership % ×

# of days owned this % 365 days

January 1–October 31 $128,000 × 100% ×

304 days = $106,608 365 days

$128,000 × 60% ×

61 days = $12,835 365 days

November 1–December 31

Time on Task: 6 minutes 14) Title: Brief Exercise 14 Difficulty: Hard Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4

= Proportionate share of tax item

Solution: We compute Harvey’s basis and the AAA and the OAA as follows:

Balances at beginning of year Net long-term capital gains Municipal interest income Expenses related to tax-exempt income Ordinary business loss Balances at end of year

Basis $32,000 2,500 1,200 ( 300) (35,400)* ($ 0)

AAA $45,000 2,500

OAA $12,000

( (52,000) ($4,500)

1,200 300)

$12,900

An ordinary business loss can create a negative balance in the AAA. However, distributions cannot create a negative basis in AAA. *Harvey’s ordinary business loss can reduce his basis to zero. The remaining $16,600 is suspended and carried forward. See Chapter 11.4, Basis and At-Risk Limitations.

Time on Task: 8 minutes 15) Title: Brief Exercise 15 Difficulty: Hard Learning Objective 1: 18.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.5 Solution: If a partner receives a partnership interest as part of a tax-deferred partnership formation, the partner’s basis is equal to the cash contributed plus the adjusted basis of the property the partner contributed to the partnership. Therefore, Willie’s basis in the partnership is equal to the basis of the land contributed, which is $35,000.

Time on Task: 3 minutes Application Problems 1) Title: Application Problem 1 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: Blitzen’s taxable income and tax liability are calculated as follows:

Gross receipts Interest income Capital gains Total income Less: Cost of goods sold Advertising expense Tax depreciation expense Rent expense Wages paid Utilities Other operating expenses Total expenses Taxable income

$1,425,000 2,200 16,800 $1,444,000 580,000 12,000 42,000 36,000 225,000 6,000 18,000 ($ 919,000) $ 525,000

Municipal interest income is not included in taxable income. Fines and penalties and entertainment expenses are not deductible for tax purposes. Blitzen’s tax liability is $110,250 ($525,000  21%).

Time on Task: 7 minutes 2) Title: Application Problem 2 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: If Lazarus sold the building, it would have a LTCG of $109,000 ($325,000 amount realized less $216,000 adjusted basis). However, because the building was donated to a qualified charitable organization, Lazarus can deduct the FMV of $325,000 as a charitable contribution. Lazarus does not recognize any gain due to the contribution.

Time on Task: 3 minutes 3) Title: Application Problem 3 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution:

The property is LTCG property so the general rule is that AAI can deduct the FMV of $32,000.

However, the charity sold the SUV and did not use it in a manner consistent with its tax-exempt purposes. Therefore, AAI’s deduction is limited to its adjusted basis of $30,000.

Time on Task: 3 minutes 4) Title: Application Problem 4 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: If Poinsettia sold the machine, the total gain would be $35,000 ($105,000 amount realized − $70,000 adjusted basis), of which Poinsettia would recapture $30,000 as ordinary income. If Poinsettia contributed this property to a qualified charitable organization, the deduction would be $75,000 ($105,000 − $30,000), using the following formula: (FMV of the property) − (The ordinary income or short term capital gain that would be recognized if the taxpayer sold the property)

Time on Task: 4 minutes 5) Title: Application Problem 5 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: Because UPI’s contribution consists of inventory that is used for the needy, it can deduct more than the adjusted basis of the property, as follows: The deduction is the lower of the: • Adjusted basis of the property (AB) + [50% × (FMV − AB)], or • 2 × AB. • •

($1,000 + [50% × ($7,000 − $1,000)] = $4,000, or 2 × $1,000 = $2,000

Therefore, UPI can deduct $2,000 for the contribution of the 200 uniforms.

Time on Task: 5 minutes 6) Title: Application Problem 6 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution a. If Greensville is an accrual-basis taxpayer, it can deduct contributions that were board approved by December 31, Year 1 as long as these are paid by April 15, Year 2. Therefore, Greensville can deduct $550,000 in Year 1 ($300,000 + $250,000). For Year 2, Greensville can deduct $575,000 ($275,000 + $300,000), and for Year 3 the deduction is $125,000. b. If Greensville was a cash-basis taxpayer, the deduction for Year 1 would be limited to $300,000. The deduction would be $825,000 ($250,000 + $275,000 + $300,000) for Year 2, and $125,000 for Year 3.

Time on Task: 6 minutes 7) Title: Application Problem 7 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: The allowable charitable contribution deduction is limited to 10% of taxable income computed before the charitable contribution deduction and the DRD. The deduction of $59,800 is computed as follows: Taxable income after the charitable contribution and DRD deduction Plus: Charitable contributions Plus: DRD deduction Taxable income before charitable contribution and DRD Limitation Deductible contribution

$468,000 79,000 51,000 $598,000  10% $ 59,800

The remaining contribution of $19,200 ($79,000 − $59,800) is carried forward for up to five years.

Time on Task: 8 minutes

8) Title: Application Problem 8 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: We apply the steps to compute the DRD: Step 1: The ownership percentage in Hotdog Inc is 15%, so the DRD percentage is 50%.

Step 2: The full DRD is $2,500 ($5,000  50%).

Step 3: If the full DRD is subtracted, then FNBI has taxable income of $655,000, so a loss is not created. Therefore, the taxable income limit test applies.

Revenue from operations Plus: Dividend – Hot Dog Inc. Plus: Capital gains Less: Operating expenses Taxable income before the DRD Less: DRD Taxable income after DRD

$ 775,000 5,000 2,500 (125,000) $ 657,500 (2,500) $ 655,000

Step 4: The taxable income limit is $657,500 × 50%, or $328,750. This is not less than the full DRD of $2,500, so the full DRD is allowed.

Time on Task: 8 minutes 9) Title: Application Problem 9 Difficulty: Hard Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: We apply the steps to compute the DRD: Step 1: The ownership percentage in Pie Inc is 38%, so the DRD percentage is 65%.

Step 2: The full DRD is $35,100 ($54,000  65%).

Step 3: If the full DRD is subtracted, then Shepards has taxable income of $9,900, so a loss is not created. Therefore, the taxable income limit test applies.

Revenue from operations Plus: Dividend – Pie Inc Plus: Capital gains Less: Operating expenses Taxable income before the DRD Less: DRD Taxable income after DRD

$297,000 54,000 9,000 (315,000) $ 45,000 (35,100) $ 9,900

Step 4: The taxable income limit is $45,000 × 65%, or $29,250. Because $29,250 is less than the full DRD of $35,100, the DRD is limited to $29,250, and Shepards’ taxable income is $15,750.

Taxable income before the DRD Less: DRD Taxable income after DRD Time on Task: 8 minutes

$ 45,000 (29,250) $ 15,750

10) Title: Application Problem 10 Difficulty: Hard Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.1 Solution: We apply the steps to compute the DRD: Step 1: The ownership percentage in Picture Inc is 10%, so the DRD percentage is 50%.

Step 2: The full DRD is $33,000 ($66,000  50%).

Step 3: If the full DRD is subtracted, Framer would recognize a loss of $12,000. Therefore, the taxable income limit test does not apply, and Step 4 is not used.

Revenue from operations Plus: Dividend—Pictures Inc. Plus: Capital gains Less: Operating expenses Taxable income before the DRD Less: DRD Taxable income after DRD Time on Task: 8 minutes 11) Title: Application Problem 11 Difficulty: Medium Learning Objective 1: 18.2

$550,000 66,000 5,000 (600,000) $ 21,000 (33,000) ($ 12,000)

Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.2 Solution: Maverick Corporation must offset short capital gains against short-term capital losses resulting in a net short-term capital gain of $1,000 ($8,000 STCG − $7,000 STCL), and long-term capital gains against long-term capital losses resulting in a net long-term capital loss of $4,000 ($6,000 LTCG − $10,000 LTCL). Netting again results in a net capital loss of $3,000 ($4,000 LTCL − $1,000 STCG). The $3,000 net capital loss cannot offset the $95,000 of operating income because net capital losses are not deductible for corporations. The $3,000 net capital loss is carried back three years and carried forward five years.

Time on Task:4 minutes 12) Title: Application Problem 12 Difficulty: Easy Learning Objective 1: 18.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.2 Solution: Kerber must compute its average gross receipts over the last three years, determined as follows: ($32,500,000 + $29,000,000 + $30,000,000) = $30,500,000 3 Because the average gross receipts of $30,500,000 exceeds the benchmark of $30,000,000, Kerber cannot use the cash method for Year 8 and must use the accrual-basis method.

Time on Task: 4 minutes 13) Title: Application Problem 13 Difficulty: Hard Learning Objective 1: 18.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.2 Solution: Book income after taxes

$520,000

Expenses deducted for book income that are not deductible for taxable income: Federal income tax expenses

109,200

Excess capital loss Entertainment expenses Income included in book income that is not included in taxable income: Municipal interest income Expenses not deducted for book income that are deducted for taxable income: Charitable contribution carryforward Tax depreciation in excess of book depreciation (78,000 − $66,000) Taxable income Time on Task: 8 minutes

3,000 4,500 (1,000) (10,000) (12,000) $613,700

14) Title: Application Problem 14 Difficulty: Hard Learning Objective 1: 18.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.2 Solution: a. Jaryn’s NOL for 2024 is computed as follows: Taxable loss before NOL carryforward and charitable contribution Plus: NOL carryforward from 2018 Net operating loss for 2024

($102,000) 38,000 ($ 64,000)

The $64,000 net operating loss cannot be carried back. It can be carried forward indefinitely and used to offset 80% of taxable income in future years. b. Jaryn can use the 2018 and 2024 NOL carryforward of $102,000 ($38,000 + $64,000) to offset 80% of taxable income in 2025. Therefore, Jaryn can use $36,000 of the NOL ($45,000 × 80%), and taxable income after the NOL is $9,000 ($45,000 − $36,000). The remaining NOL of $66,000 ($102,000 − $36,000) is carried forward to future tax years. Note that Jaryn will use the oldest NOL being carried forward first, so it will use the 2018 NOL before the 2024 NOL. NOLs are tracked separately for each year.

Time on Task: 8 minutes 15) Title: Application Problem 15 Difficulty: Medium Learning Objective 1: 18.2 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.2

Solution: Cancun’s ending retained earnings is computed as follows: Retained earnings, January 1 Add: Net income per books Add: Other increases Less: Distributions to shareholders ($35,000 + $16,000) Less: Other decreases Retained earnings, December 31 Time on Task: 5 minutes

$327,000 285,000 N/A (51,000) N/A $561,000

16) Title: Application Problem 16 Difficulty: Hard Learning Objective 1: 18.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.3 Solution: a. Blizzard’s foreign tax credit is limited to the lower of: 1. Foreign tax paid ($31,000), or 2. U. S. tax on worldwide income ×

$116,130 ×

Foreign source taxable income Worldwide taxable income

$108,000 = $22,680 $445,000 + $108,000

Therefore, Blizzard’s foreign tax credit is limited to $22,680. b. Blizzard has a foreign tax credit carryback/carryforward of $8,320 ($31,000 − $22,680).

Time on Task: 5 minutes 17) Title: Application Problem 17 Difficulty: Medium Learning Objective 1: 18.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.3 Solution:

a. To compute the amount of general business credit that Workman can use this year, we must compute the general business credit limitation, as follows: Taxpayer's net income tax − [(Net regular tax liability − $25,000) × 25%] = $110,000 − [($110,000 – $25,000)  25%] = $110,000 − $21,250 = $88,750 b. Workman’s general business credit is limited to $88,750, so Workman’s tax liability is $21,250 ($110,000 − $88,750). c. The unused general business credit is $9,250 ($98,000 − $88,750), and it can be carried back one year and then carried forward 20 years.

Time on Task: 6 minutes 18) Title: Application Problem 18 Difficulty: Medium Learning Objective 1: 18.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.3 Solution: Because this is a certified historic structure, the credit percentage is 20%. Therefore, the total rehabilitation credit is $78,000 ($390,000 × 20%). The credit must be spread evenly over five years, so the credit claimed for the current year is $15,600 ($78,000/5). Downtown’s adjusted basis in the building must be reduced by the amount of the credit, so the basis after the credit is $1,262,000 ($950,000 + $390,000 − $78,000).

Time on Task: 5 minutes 19) Title: Application Problem 19 Difficulty: Medium Learning Objective 1: 18.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.3 Solution: The WOTC is computed as follows for Grease, using the 40% rate for all individuals: Targeted Group Long-term unemployment recipients

Maximum Qualified Wages $ 6,000

Credit $2,400

Individuals having a physical or mental disability Members of families receiving Targeted Assistance for Needy Families Total credit Time on Task: 8 minutes

6,000

2,400

10,000

4,000 $8,800

20) Title: Application Problem 20 Difficulty: Medium Learning Objective 1: 18.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.3 Solution: Tadpole’s qualifying research expenses for the year are $130,000 ($200,000  65%) because they are paying an outside firm to perform the research. Tadpole’s research credit is $5,000 computed as follows: Qualifying research expenses $130,000 Less: Base research expenses (105,000) Incremental research expenses $ 25,000 Credit percentage × 20% Research credit $ 5,000 Time on Task: 6 minutes 21) Title: Application Problem 21 Difficulty: Medium Learning Objective 1: 18.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.3 Solution: HealthNow is an eligible small business because it had gross receipts of $1,000,000 or less in the previous year. The expenses that qualify for the credit that are greater than $250 but not greater than $10,250 are $4,650 ($4,900 − $250). Therefore, the disabled access credit is $2,325 ($4,650 × 50%). The basis of the building is increased by $2,575, the difference in the capital improvements of $4,900 less the credit of $2,325.

Time on Task: 6 minutes 22)

Title: Application Problem 22 Difficulty: Medium Learning Objective 1: 18.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.3 Solution: The qualified childcare expenditures for Mandella are $553,000 ($465,000 + $88,000).

Therefore, the credit is $138,250 ($553,000 × 25%). The basis of the childcare facility is reduced to $348,750 ($465,000 – [$465,000 × 25%]). The deduction for training and salaries is reduced to $66,000 ($88,000 – [$88,000 × 25%]).

Time on Task: 5 minutes 23) Title: Application Problem 23 Difficulty: Medium Learning Objective 1: 18.3 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.3 Solution: To compute this credit, we must first determine the percentage of wages that is eligible for the credit. The minimum credit of 12.5% is increased by 0.25 percentage points for each percentage point by which the wages paid exceed 50%. Tutu’s credit percentage is computed as follows: Percent of wages paid for medical and family leave Less: Minimum percentage required Excess percentage paid

Plus: Minimum credit allowed Credit percentage allowed

75% ( 50%) 25% × 0.25 6.25% 12.50% 18.75%

To compute Tutu’s credit, 18.75% is multiplied by the qualifying wages paid. Tutu’s credit is $28,125 ($150,000 × 18.75%).

Time on Task: 6 minutes 24) Title: Application Problem 24 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Analytic

Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4 Solution: Colin’s loss allocation is computed as follows:

January 1 – March 8 $188,000 loss  50%  67/365 = $17,255 March 9 – December 31 $188,000  40%  298/365 = $61,396 Colin’s loss allocation is thus $78,651 ($17,255 + $61,396).

Time on Task: 6 minutes 25) Title: Application Problem 25 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.4 Solution: a. Separately stated. b. Separately stated. c. Not separately stated. d. Not separately stated. e. Separately stated. f. Separately stated. g. Separately stated. h. Not separately stated. i. Separately stated. j. Separately stated. k. Not separately stated.

Time on task: 6 minutes 26)

Title: Application Problem 26 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4 Solution: We begin by splitting these tax items into the bucket items and the separately stated items and using the bucket items to compute ordinary business income of $1,187,000.

Bucket Items Gross receipts Less: COGS Salaries and wages Utilities Rent expense Advertising Insurance expense Depreciation Ordinary business income

$2,600,000 ( 569,000) ( 515,000) ( 38,000) ( 178,000) ( 15,000) ( 26,000) ( 72,000) $1,187,000

Separately Stated Items Municipal interest income

$ 1,200

Net STCG Net section 1231 gain

$ 8,800 $22,000

Charitable contributions Section 179 expense

$39,000 $33,000

Alvin’s K-1 would reflect 35% of the ordinary business income and each separately stated item, as follows: Total Alvin’s Allocation (35%) Ordinary business income $1,187,000 $415,450 Muni. interest income $ 1,200 $ 420 Net short-term capital gain $ 8,800 $ 3,080 Net Section 1231 gain $ 22,000 $ 7,700 Charitable contributions $ 39,000 $ 13,650 Section 179 expense $ 33,000 $ 11,550 Alvin’s salary of $130,000 would be reported to him on his W-2 from Beeker.

Time on Task: 10 minutes 27) Title: Application Problem 27 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4

Solution: Shuchang’s ending basis in Lee Corporation of $68,300 is calculated as follows: Beginning basis $44,500 Plus: Ordinary business income 29,000 Plus: Interest income 1,100 Plus: Long-term capital gain 12,500 Available basis $87,100 Less: Distributions (13,000) Less: Section 179 ( 5,200) Less: Nondeductible entertainment expense ( 600) Ending basis $68,300 Time on Task: 6 minutes 28) Title: Application Problem 28 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4 Solution: Lucille’s ending basis in Kudrow Corporation of $0 is calculated as follows: Beginning basis Plus: Ordinary business income Plus: Municipal interest income Plus: Short-term capital gain Available basis Less: Distributions Ending basis

$50,000 22,000 1,000 8,000 $81,000 ( 81,000) $ 0

Distributions reduce basis to zero but can never create a negative basis. If the distributions exceed basis, then the excess of $4,000 is treated as a capital gain.

Time on Task: 6 minutes 29) Title: Application Problem 29 Difficulty: Hard Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting

Standard 3: Bloom's || Application Section Reference 1: 18.4 Solution: Mark’s ending basis in Davenport Corporation is $0, calculated as follows: Beginning basis Plus: Dividend income Plus: Section 1231 gain Available basis Less: Distributions Available basis Ordinary business loss Ending basis

$33,000 4,000 6,000 $43,000 (20,000) $23,000 (23,000) $ 0

Distributions reduce basis to zero but can never create a negative basis. Ordinary business losses are deductible to the extent of any remaining basis after distributions are considered. Because available basis after the distribution is $23,000, only $23,000 of the $25,000 loss can be deducted on Mark’s individual income tax return. The remaining $2,000 is carried forward to the following year. Once basis is restored, then the remaining ordinary loss will be considered to determine if it is deductible in that carryforward year.

Time on Task: 10 minutes 30) Title: Application Problem 30 Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4 Solution: J can deduct $90,000 of the loss on his tax return. The S corporation has a loss of $400,000 and J is a 25% shareholder, so his portion of the loss is $100,000 ($400,000  25%). J can deduct the loss to the extent of his basis in his stock and his debt (loan) basis. J’s stock basis is $60,000 and he will reduce his stock basis by $60,000 of the ordinary loss. And, because J personally loaned the S corporation $30,000, he has debt basis of $30,000 and can deduct another $30,000 of the loss to reduce his debt basis to zero. The remaining $10,000 of loss is suspended and carried forward to next year.

Time on Task: 4 minutes 31) Title: Application Problem 31 Difficulty: Medium Learning Objective 1: 18.4

Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.4 Solution: We compute Hui’s basis and the AAA and the OAA as follows: Basis AAA Balances at beginning of year $ 22,000 $ 45,000 Ordinary business income 83,000 166,000 Section 1231 gain 1,650 3,300 Life insurance proceeds from key officer 25,000 Premiums paid on key officer life insurance (1,200) Section 179 expense (4,000) (8,000) Balances at end of year $126,450 $206,300 Time on Task: 8 minutes

OAA $ 1,200

50,000 (2,400) $48,800

32) Title: Application Problem 32 Difficulty: Medium Learning Objective 1: 18.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.5 Solution: Revenue $80,000 Insurance expense ( 4,800) Salaries paid (10,000) Ordinary business income $65,200 The other items are separately stated and reported on Schedule K of Form 1065.

Time on Task: 5 minutes 33) Title: Application Problem 33 Difficulty: Hard Learning Objective 1: 18.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.5 Solution:

a. The $50,000 recourse loan is allocated based on the loss-sharing ratios and the $20,000 nonrecourse loan is allocated based on the profit-sharing ratios. The bases in their partnership interests are increased as follows for Year 1: Peyton’s Basis $32,500 14,000 $46,500

Recourse Loan – $50,000 Nonrecourse Loan – $20,000 Total increase in basis

Greg’s Basis $17,500 6,000 $23,500

b. For Year 2, Peyton’s basis will be reduced by $14,000 ($20,000 × 70%), and Greg’s basis will be reduced by $6,000 ($20,000 × 30%).

Time on Task: 10 minutes 34) Title: Application Problem 34 Difficulty: Hard Learning Objective 1: 18.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.5 Solution: First, the initial basis must be calculated for Ralph and Wayne for the assets transferred on the formation of the partnership. Ralph contributed cash of $50,000 so that is his initial basis. Wayne contributed land with an adjusted basis of $35,000 so that is his initial basis.

Next, the recourse liability attached to the land of $20,000 must be addressed. Wayne has relief of debt so his basis will decrease by the debt assumed by the partnership of $20,000. Last, both Ralph and Wayne will collectively increase the bases of their partnership interests by their share of the $20,000 debt (50% for each):

Asset contributed Debt relief Debt assumed Basis Time on Task: 10 minutes

Ralph $50,000 N/A 10,000 $60,000

35) Title: Application Problem 35 Difficulty: Hard Learning Objective 1: 18.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting

Wayne $35,000 (20,000) 10,000 $25,000

Standard 3: Bloom's || Application Section Reference 1: 18.5 Solution: We compute Gadzook’s basis as follows, using the ordering rules discussed in the chapter:

Balance at beginning of the year Plus: Interest income Plus: Dividend income Available basis Less: Cash distribution Available basis

Basis $16,000 600 ($1,000  60%) 1,320 ($2,200  60%) $17,920 (17,920) $ 0

The distribution of $20,000 is in excess of available basis. Gadzook’s has a taxable gain of $2,080 ($20,000 − $17,920) because the cash distributed exceeded the basis in the partnership interest. Gadzook’s share of the ordinary business loss of $28,800 ($48,000  60%) and the charitable contribution of $1,080 ($1,800  60%) is suspended and not deductible in the current year. Both items will be carried forward indefinitely and can be used in the future when there is sufficient basis in Gadzook’s partnership interest.

Time on Task: 8 minutes 36) Title: Application Problem 36 Difficulty: Medium Learning Objective 1: 18.5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.5 Solution: We compute Lily’s basis as follows: Balance at beginning of the year Ordinary business income ($100,000  40%) Dividend income ($5,000 × 40%) Basis available Cash distribution Basis available Decrease in partnership debt ($45,000 × 40%) Long-term capital loss ($12,000 × 40%) Balance at end of year Time on Task: 10 minutes

Basis $ 88,000 40,000 2,000 $130,000 (35,000) $ 95,000 (18,000) (4,800) $ 72,200

37) Title: Application Problem 37 Difficulty: Medium Learning Objective 1: 18.6 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Knowledge Section Reference 1: 18.6 Solution: Maple Avenue Assembly will lose its tax-exempt status and its income will be taxable. To qualify as a tax-exempt organization, the organization must operate exclusively for a tax-exempt purpose. Influencing legislation or political parties is not an acceptable purpose.

Time on Task: 4 minutes 38) Title: Application Problem 38 Difficulty: Medium Learning Objective 1: 18.6 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Reporting Standard 3: Bloom's || Application Section Reference 1: 18.6 Solution: Unrelated business income must: • Be from a business regularly carried on, and •

Be unrelated to the organization’s exempt purpose.

The income earned from the cafe of $400,000 is unrelated business income and will be taxed at a 21% tax rate.

Time on Task: 3 minutes Tax Planning Problems 1) Title: Tax Planning Problem 1 Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 18.1 Solution: Because the ex-dividend date is March 15, the 91-day period runs from January 29 to April 29.

To qualify for the DRD, Heirloom must own the stock for at least 46 days during this period. If

Heirloom purchased the stock on February 10, the corporation must hold the stock until March 28 to qualify for the DRD. [[COMP: See submitted file: "Carnes_I2025_Ch18_SM_TaxPlanningProblem1.pdf"]]

Time on Task: 8 minutes 2) Title: Tax Planning Problem 2 Difficulty: Difficult Learning Objective 1: 18.4 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis Section Reference 1: 18.4 Solution: Tucker’s beginning basis is $55,000. He can increase this basis by the short-term capital gain of $5,000 giving him an available basis of $60,000 before any distribution or deduction for the ordinary business loss. Tucker’s ordinary business loss is $65,000. Because distributions are considered before deducting the ordinary business loss, any distribution will reduce his ability to deduct the ordinary business loss on his tax return. If Tucker would like to deduct his ordinary business loss up to his available basis of $60,000, then he should not take any distributions in the current year. Even without a distribution, Tucker will have a suspended loss of $5,000 ($65,000 − $60,000).

Time on Task: 8 minutes 3) Title: Tax Planning Problem 3 Difficulty: Difficult Learning Objective 1: 18.5 Standard 1: AACSB || Analytic Standard 2: AICPA || PC: Decision Making Standard 3: Bloom's || Analysis

Section Reference 1: 18.5 Solution: As a general partner, Brooks will have to pay income tax and self-employment tax on both the guaranteed payment of $200,000 for services rendered and his share of the ordinary business income of $50,000.

Net earnings from self-employment  7.65% reduction for self-employment tax Actual net earnings

$250,000 × 92.35% $230,875

Social Security: $168,600 (max. for 2024) × 12.4% = $20,906 Medicare: $230,875 × 2.9% = $6,695 Additional Medicare: ($230,875 − $200,000 threshold) × 0.9% = $278 Income tax: [($210,000 − $191,150) × 32%] + $39,110.50 = $45,143 Total tax liability: $73,022 ($20,906 + 6,695 + 278 + $45,143) Time on Task: 10 minutes Communication Problem 1) Title: Communication Problem: S Corporation—Number of Shareholders Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Communication Standard 2: AICPA || PC: Communication Standard 3: Bloom's || Analysis Section Reference 1: 18.4 Solution: Hello Jose and Hermella, I am sorry to hear of your pending divorce. This must be a very hard time for both of you. You have asked for advice regarding the tax consequences of your divorce as it relates to the S corporation ownership. The number of shareholders in an S corporation is limited to 100.

However, more than 100 individuals can invest in an S corporation because husbands and wives are treated as one shareholder. This rule also applies to former spouses, so after the divorce the S corporation will still have only one shareholder.

Please let me know if I can be of any further assistance.

Sincerely, Carnes & Youngberg, CPAs Time on Task: 12 minutes Ethics Problem

1) Title: Ethics Problem: S Corporation—Reasonable Salary Difficulty: Medium Learning Objective 1: 18.4 Standard 1: AACSB || Ethics Standard 2: AICPA || PC: Ethical Conduct Standard 3: Bloom's || Evaluation Section Reference 1: 18.4 Solution: If Jake is performing services for CRIC, he must be paid a reasonable wage, and payroll taxes are also required. If the compensation paid to Jake is unreasonably low, the IRS can assess penalties against him. Under SSTS No. 1.2.6. Knowledge of Errors, "A member should promptly inform a taxpayer upon becoming aware of the taxpayer’s failure to file a required return, [or] an error in a previously filed return." Members of the AICPA should follow the applicable standards whenever they become aware of an error in a taxpayer’s previously filed tax return; a member should inform the taxpayer promptly upon becoming aware of an error in a previously filed return; and a member also should advise the taxpayer of the potential consequences of the error and recommend the corrective measures the taxpayer should take. In addition, IRS Circular 230 provides similar expectations for practitioners. The IRS can assess monetary penalties under Circular 230, and the IRS has the authority to censure, suspend, or disbar the CPA from practice before the IRS (Circular 230, Subpart C). The tax accountant should inform Jake of the above and provide that a reasonable salary be paid to Jake. If Jake refuses to take appropriate action, the CPA should consider resigning from the engagement.

Time on Task: 10 minutes Research Problem 1) Title: Research Problem: Choosing a Business Entity Type Difficulty: Difficult Learning Objective 1: 18.1, 2, 4, 5 Standard 1: AACSB || Analytic Standard 2: AICPA || AC: Research Standard 3: Bloom's || Analysis Section Reference 1: 18.1, 2, 4, 5 Solution: Selecting a business entity type is a very important decision. Marvin needs to understand the tax consequences to himself as well as Mooselodge for each business entity type. Providing Marvin the chart below that compares some of the main tax issues for each entity type will help Marvin make a wise decision.

Tax issue Highest income tax rate?

Who pays the tax?

Sole Proprietor 37%

Partnership/LLC S corporation 37% 37%

C corporation 21%

Individual, Schedule C

Individual, Schedule E

Corporation, Form 1120

Individual, Schedule E

Personal liability for debt?

Single or double taxation?

Limitation on losses deductible by owner?

Yes

Yes, if general partner

No

No

Single

Single

Single

Double

Yes, to extent of investment

Yes, to extent of investment

Yes, to extent of investment

Selfemployment tax?

Payment to owner deductible?

Yes

Yes

No

No losses are deductible by owners. Losses are carried forward at entity level.

N/A

No, just a distribution

No, unless a guaranteed payment

Yes, through wages paid

Yes, through wages paid

Marvin has indicated that Mooselodge will have losses for the first four years. If Marvin chooses any of the entity types except a C corporation, he will be able to deduct those losses against other income to the extent of his investment basis. If he operates the business as a sole proprietor or partnership/LLC, he can deduct losses to the extent of the business debt also. An S corporation or C corporation will protect Marvin from liabilities if the business is not successful because he will have limited liability. He would also have limited liability as an LLC member. Based only on the information provided by Marvin, an S corporation would be a smart choice for the entity type.

An S corporation is a flow-through entity which will allow Marvin to immediately use the losses incurred in the first four years against other income on his personal tax return. Marvin can pay himself a salary that is deductible by the S corporation and avoid potential liability and selfemployment tax.

Time on Task: 20 minutes Excel Problem 1) Title: Excel Problem: Dividends Received Deduction Difficulty: Medium Learning Objective 1: 18.1 Standard 1: AACSB || Technology Standard 2: AICPA || AC: Technology and Tools Standard 3: Bloom's || Synthesis Section Reference 1: 18.1 Solution:

Dividends Received Deduction Case 1: We apply the steps to compute the DRD: Step 1: The ownership percentage in the dividend paying corporation is 12%, so the DRD percentage is 50%.

Step 2: The full DRD is $5,000 ($10,000  50%).

Step 3: If the full DRD is subtracted, Cherry has taxable income of $10,000, so a loss is not created. Therefore, the taxable income limit applies.

Taxable income before the DRD Less: DRD Taxable income after DRD

$15,000 ( 5,000) $10,000

Step 4: The taxable income limit is $15,000 × 50%, or $7,500. This is not less than the full DRD of $5,000 so the full DRD is allowed.

Case 2: We apply the steps to compute the DRD: Step 1: The ownership percentage in the dividend paying corporation is 25%, so the DRD percentage is 65%.

Step 2: The full DRD is $6,500 ($10,000  65%).

Step 3: If the full DRD is subtracted, Cherry has taxable income of $2,500, so a loss is not created. Therefore, the taxable income limit test applies.

Taxable income before the DRD Less: DRD Taxable income after DRD

$9,000 (6,500) $2,500

Step 4: The taxable income limit is $9,000 × 65%, or $5,850. Because $5,850 is less than the full DRD of $6,500, the DRD is limited to $5,850, and Cherry’s taxable income is $3,150 ($9,000 − $5,850).

Case 3: We apply the steps to compute the DRD: Step 1: The ownership percentage in the dividend paying corporation is 32%, so the DRD percentage is 65%.

Step 2: The full DRD is $6,500 ($10,000  65%).

Step 3: If the full DRD is subtracted, Cherry would recognize a loss of $500. Therefore, the taxable income limit does not apply, and Step 4 is not used.

Taxable income before the DRD Less: DRD Taxable income after DRD

$6,000 ( 6,500) ($ 500)

Time on Task: 20 minutes CPA Exam Preparation: Task-Based Simulation 1) Title: CPA Exam Preparation: Task-Based Simulation: S Corporation Distributions Difficulty: Hard Learning Objective 1: 18.4 Standard 1: AACSB || Knowledge Standard 2: AICPA || AC: Measurement Analysis and Interpretation Standard 3: Bloom's || Analysis Section Reference 1: 18.4 Solution: Rationale

A

B $42,900

Calculate Classic Brides's ordinary business income.

Calculate Lydia’s ending stock basis.

$31,120 $75,700

Calculate ending AAA for year 3.

If Classic Brides made a cash distribution to Lydia on 12/31 of $35,000, what is Lydia’s ending loan basis?

$5,000

Calculate ordinary business income

Book Income Sales

Separately Stated

Ordinary Business Income

Items

$135,000

$135,000

Tax exempt interest income

900

0

Depreciation recapture income

4,400

4,400

800

0

800

Key employee life insurance proceeds received

10,000

0

10,000

Short term capital gain

2,500

0

2,500

Total income

$153,600

$139,400

Cost of goods sold

$48,000

$48,000

Salary paid to Lydia

15,000

15,000

Rent expense

24,000

24,000

Advertising

1,000

1,000

Administrative expenses

8,500

8,500

Charitable contributions

500

0

Dividend income

900

500

Premiums paid on key employee life insurance Total expenses

Book Income/Ordinary business income

3,800

0

$100,800

$96,500

52,800

42,900

3,800

Ordinary business income reflects income from operations that is not separately stated. A separately stated item is any item with tax attributes that could affect each S corporation shareholder differently.

Tax exempt interest income and key employee life insurance proceeds received are tax exempt and not reported as income on the tax return. The premiums paid on key employee life insurance are not deductible since the corresponding income is not included in income.

Calculate Lydia’s ending stock basis

A shareholder’s basis will be increased or decreased by contributions, operations and distributions during the year. Lydia is a 40% shareholder. The salary paid to Lydia does not reduce Lydia’s basis. The salary was taken as a deduction in calculating ordinary business income.

Lydia's beginning stock basis

$10,000

Ordinary business income (40%)

17,160

Tax exempt interest income (40%)

360

Dividend income (40%)

320

Key employee life insurance proceeds received (40%)

4,000

Short term capital gain (40%)

1,000

Less: Charitable contributions (40%) Premiums paid on key employee life insurance (40%)

-200 -1,520

Lydia's ending stock basis

$31,120

Calculate ending AAA for year 3

Beginning AAA

$30,000

Ordinary business income

42,900

Dividend income

800

Short term capital gain

2,500

Charitable contributions

-500

Ending AAA

$75,700

The accumulated adjustments account (AAA) is an account that reports undistributed earnings of an S corporation that have been previously taxed to the shareholders. Distributions from the AAA are tax free to the extent of the AAA. Tax exempt income and related expenses do not affect AAA. Instead, these items are reflected in the Other Adjustment Account (OAA). The AAA can have a negative balance due to losses. However, distributions may not make the AAA negative or increase a negative balance.

Lydia’s ending loan basis

Since Lydia loaned $5,000 to the S corporation, she has a loan basis of $5,000. Pass through losses can reduce loan basis, but distributions do not. Therefore, Lydia’s loan basis is still $5,000 after the distribution.

Time on Task: 25 minutes

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