Taxation

Taxation
COMPREHENSIVE PROBLEM
92. Carol is a single mother who owns a wholesale auto parts distributorship. The business
is organized as a sole proprietorship. Her business has advanced, and she can
no longer devote the time necessary to do her own tax return. Because she always
has prepared her own return, Carol is familiar with most tax rules applicable to her
business and personal affairs. However, she has come to you for advice with respect
to a number of items she paid during the current year. You are to determine
whether she can take a deduction for the expenditures in the current year.a. Carol purchased a small building on March 2 to use as a warehouse for her
auto parts inventory. To purchase the building, she borrowed $180,000 on a
30-year loan and paid $20,000 in additional cash. Carol also incurred $3,200
in legal and other fees to purchase the building. The bank charged her $3,600
in points (prepaid interest) to obtain the loan. After acquiring the building,
Carol spent an additional $25,000 to renovate it for use as a warehouse. The
$25,000 included $8,000 for painting.b. Carol had her office building painted at a cost of $14,000 and paid $6,000 to
have it landscaped. She paid for the building renovation in part a and the office
building work by borrowing $60,000 on April 1 at 7% interest. (See part f for
details of the interest payments.)c. On April 1, Carol prepaid a 1-year fire insurance policy on her 2 buildings.
The policy cost $1,500, and the insurer required the prepayment. On September
1, Carol prepaid a $5,000, 2-year maintenance contract on the buildings.d. Carol started a self-insured medical reimbursement plan for her employees this
year. Based on actuarial assumptions, she deposited $13,500 in a fund to pay
employees’ medical expenses. Actual payments from the fund totaled $11,200.e. Carol purchased a new automobile costing $32,000. She can document that
her business use of the automobile came to 90% and that her out-of-pocket
operating costs totaled $3,600.f. Carol paid the following interest on business-related loans:
Warehouse $15,300
Office building 4,000
Renovation loan 5,400
The renovation loan was for $60,000. Because she spent only $45,000 renovating
the new building and painting and landscaping the old one, she used
the additional $15,000 to purchase city of Seattle bonds with a yield of 6%
.
g. Carol became active in politics and contributed $1,000 to the presidential
campaign of an independent candidate. She made the contribution because
she believed that, if elected, the candidate would institute policies beneficial to
her business. The candidate lost the election and immediately started a grassroots
lobbying organization. The purpose of the organization is to keep track
of elected officials’ campaign promises and report to the public when they vote
contrary to their stated campaign promises. Carol paid $1,600 in dues to join
the lobbying organization.h. Carol’s oldest son began college during the current year. She paid his tuition
and living expenses, a total of $13,300, out of the company’s checking account.
During the summer, her son worked for the business, and Carol paid him
$4,300, the same amount she paid other college students working during the
summer. Because she consults her son from time to time on the operation of
the business, she thinks that at least some of the $13,300 should be deductible.i. Carol has always itemized her deductions. This year, her mother and father
retired and could no longer afford the mortgage interest and property taxes on
their home. Rather than have them sell the house, Carol made the payments for
them. They received a statement from their bank indicating that a total of
$8,125 in mortgage interest and taxes were paid in the current year. Carol knows
that mortgage interest and property taxes are deductible as itemized deductions
and would like to add them to her personal interest and property tax payments.j. Because of the success of her business, Carol has received many offers to invest
in various business ventures. One offer was to establish a chain of nursing
homes in Florida. Carol spent two weeks in Florida evaluating the prospects of
the proposed venture and incurred costs of $2,100. After careful consideration,
she decided the venture was too risky and decided not to expand into the
health-care business.INTEGRATIVE PROBLEM
97. Rufus and Rhonda are a married couple with 3 dependent children, all under 16
years of age. Rufus, 46, is an executive with Plowshare Corporation. Rhonda, 39,
is a self-employed attorney.
Rufus receives an annual salary of $78,000. He participates in Plowshare’s
qualified pension plan by contributing 4% of his annual salary, which is matched by
Plowshare. Rufus also receives group term life insurance at twice his annual salary.
The coverage costs Plowshare $2,100. All employees are covered by a medical insurance
policy. (Rufus’s policy costs $2,300.) He also participates in the company’s
flexible benefits plan by paying $200 per month into the plan. During the year,
Rufus submits claims totaling $1,800 to the plan. An additional benefit that only
top-level executives such as Rufus enjoy is the payment of $2,300 in country club
dues by Plowshare. Although Rufus occasionally entertains clients at the club, his
primary use of the facility is personal.
Rhonda bills clients a total of $125,000 for services rendered during the current
year. She receives $17,000 in payments from billings in prior years and
$87,000 from current-year billings. Rhonda pays the following expenses related to
her legal practice:
Office rent $14,400
Secretary’s salary 24,000
Withholdings from secretary’s salary
Federal income taxes $2,250
State income taxes 520
Social Security taxes 1,836 4,606
Matching Social Security tax payment 1,836
Entertainment costs 4,000
Seminar costs 1,155
Insurance on building—2 years prepaid on
August 1 1,600
Supplies 2,250
Bar association dues 600
State licensing fee 725
Automobile costs 4,700
Business gifts 850
Salary paid to Rhonda 64,000
Salary paid to Rhonda’s son 2,500
In addition to these out-of-pocket costs, Rhonda determines that $2,400 in
accounts receivable from previous years’ billings are uncollectible.
The entertainment costs consist of the following:
Dues to social club $1,000
Meals while discussing cases with clients 1,200
Open house 1,800
Rhonda has records that show that she uses the club 70% of the time for entertainment
directly related to business, 10% for entertainment associated with her
business, and 20% for personal purposes. The open house costs consist of $1,400
for food and $400 for a jazz combo at a reception she hosted for clients when she
moved into her new offices this year.
Rhonda uses her automobile extensively in her business. She keeps a log to record
business miles and related costs. Her records show that she drove 10,000
business miles and 3,000 personal miles during the current year. In past years, she
had always kept track of her business miles but failed to keep an accurate record of
her actual costs. Accordingly, her records indicate that she has never depreciated
any of the $26,000 cost of the automobile she purchased 2 years ago—she has
used the standard mileage rate method.
Every year, Rhonda gives her top 8 clients a gift to thank them for their support
of her practice. This year, she gives each client a marble paperweight engraved
with the client’s name. Each paperweight costs $75 plus $5 for engraving and $5
for gift wrapping.
The seminar costs relate to a 3-day meeting in New York on a legal topic involving
her biggest client. Because of a special airline promotion, she takes along her 16-
year-old son free. However, she has to pay $200 per night for her hotel room instead
of the $175 per night single rate. A summary of the seminar costs is as follows:
Airfare $325
Lodging (3 nights @ $200 each) 600
Meals (including $80 for her son) 200
Taxi to and from the airport 30
Rhonda pays the $2,500 salary to her son for cleaning up after the open house
reception. Although she could hire a service to do the job for $400, he needs the
money to buy a used motorcycle.
Rufus is hit by a car one morning while he is out jogging. The driver is at fault,
and his insurance company pays Rufus $8,000 for his pain and suffering and
$13,000 of his $15,500 medical expenses. The remaining medical expenses are
paid by Plowshare’s medical insurance policy. Rufus also receives $2,650 in disability
pay from the Plowshare policy for the time he misses from work recovering
from the injury.
Rufus and Rhonda have the following investment-related items during the current
year:
Interest on savings account $ 1,900
Interest on Puerto Rico development bonds 7,000
Cash dividends on stock 3,200
Stock dividend shares
(300 shares received when the market value of
the stock was $40 per share) 12,000
Early in the year, Rhonda inherits 900 shares of stock from her grandmother.
The total value of the shares is $16,000. Later in the year, the stock value begins
to fall rapidly, and she sells the shares at a $4,500 loss.
Rufus and Rhonda own a cabin in the mountains. They use it on weekends
and for short holidays and rent it out whenever they can. During the current year,
they use the cabin 25 days and rent it out 75 days. Details on the cabin income
and expenses are as follows:
Rental income $10,000
Mortgage interest 9,000
Property taxes 2,300
Utilities and maintenance 840
Depreciation (unallocated) 7,500
In addition, Rufus and Rhonda have $19,220 in other allowable itemized
deductions. Based on the information provided, calculate Rufus and Rhonda’s taxable
income and their tax liability. Assume that they are cash basis taxpayers and
want to be as aggressive as possible in taking their allowable deductions.COMPREHENSIVE PROBLEM
93. Calzone Trucking Company is a corporation that is 100% owned by Fred Calzone.
Before he incorporated in 2010, Fred had operated the business as a sole proprietorship.
The taxable income (loss) of Calzone for 2010 through 2012 is as follows:
2010 2011 2012
Taxable income (loss) $32,000 $(64,000) $18,000
The 2012 taxable income includes a net long-term capital gain of $4,000. Calzone
Trucking’s 2013 operating income is $43,300 before considering the following
transactions:
a. A hailstorm caused part of the roof of the truck barn to collapse. A truck inside
sustained damage from the falling debris. The truck barn had a fair market
value of $59,000 before the damage and an adjusted basis of $35,000. Repairs
to the roof cost $13,200, of which $9,700 was reimbursed by insurance. The
truck, which had an adjusted basis of $35,000, was worth $62,000 before the
damage and had a fair market value after the damage of $37,000. Calzone
Trucking’s insurance company paid $16,600 for the damages.
b. Another truck was totally destroyed when its brakes failed and it plunged off a
cliff. Fortunately, the driver was able to jump from the truck and escaped
unharmed. The truck, which had an adjusted basis of $24,000, was worth
$30,000 before the accident. Calzone received $13,700 from its insurance
company for the destruction of the truck. In addition, the company was cited
for failure to properly maintain the truck and paid a $7,250 fine to the state
trucking commission.
c. Calzone sold equipment that had become obsolete for $10,800. The equipment
had cost $28,000, and depreciation of $15,400 had been taken on it
before the sale.
d. Calzone sold stock it owned in two other companies. Retro Corporation
stock, which had cost $21,400, sold for $36,200. Shares of Tread Corporation
stock with a cost of $62,100 sold for $31,700. Both stocks had been purchased
in 2009.
e. Fred’s son wanted to start a delivery business. To help his son out, Fred sold
him one of Calzone’s used trucks for $8,000. The truck had a fair market
value of $15,200 and an adjusted basis of $10,100 at the date of the sale.
Calculate Calzone Trucking’s 2013 taxable income. Indicate the amount and the
effect of any carryforwards or carrybacks on Calzone Trucking’s current, past, or
future income.
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