October 26, 2012

CONCEPTS IN FEDERAL TAXATION

CHAPTER 8:TAXATION OF INDIVIDUALS

ADMINISTRATIVE

Attendance Midterm 1

Pass out examsIncome dividend—5 points

Research projectFill out spreadsheetInclude email!

HW Problems:Assignment #9Chapter 8P#46, 48, 52, 55, 57

Extra problems:

HOMEWORK PROBLEMS

Keith bought his home several years ago for $110,000. He paid $10,000 down on the purchase and borrowed the remaining $100,000. When the home is worth $230,000 and the balance on his mortgage is $40,000, Keith borrows $120,000 using a home equity loan. Keith uses the proceeds of the loan to pay off some gambling debts. During the year, Keith pays $3,200 in interest on the original home mortgage and $7,600 in interest on the home equity loan. What is Keith’s allowable itemized deduction for interest paid?

#44

Allowable home mortgage interest deduction: Interest paid on acquisition debt of up to

$1,000,000Must be used to acquire, construct, or substantially

improve residenceInterest paid on home equity loans of up to

$100,000Proceeds of the home equity loan may be used for

any purposeTotal acquisition debt and home equity debt

cannot exceed the fair market value of the property

Debt must be secured by the taxpayer’s qualifi ed residence

#44

Total debt: $160,000 ($40,000 + $120,000)Less than FV ($230,000)

Only interest on $100,000 of the home equity loan is deductible: $6,333 [$7,600 x ($100,000 ÷ $120,000)]

The remaining $1,267 of interest is considered personal interest and is not deductible

All of the interest on the original home mortgage ($3,200) qualifi es for deduction

Keith’s total interest deduction is $9,533 ($6,333 + $3,200)

#44

Stoycho and Selen are married and have the following investment income for 2011 and 2012:

2011 2012 Interest on U.S. Treasury notes $ 1,200$ 1,400Cash dividends 3,000 2,200Interest on savings 2,000 1,500Interest on State of Montana bonds 800 800Net long-term capital gain 1,000 500 Their adjusted gross income before considering the investment income is $84,000 in 2011 and $73,500 in 2012. Stoycho and Selen pay $9,000 in investment interest in 2011 and $5,000 in 2012. The investment interest is incurred to acquire all the investments in their portfolio. Write a letter to Stoycho and Selen explaining how much investment interest they can deduct in 2011 and 2012.

#48

2011:The investment interest deduction is limited to net

investment incomeInvestment income is $3,200 ($1,200 + $2,000)

The interest received on the municipal bonds is tax-exempt Not included

The net long-term capital gain cannot be used in the calculation of gross investment income because it will

be taxed at 15%Dividends receive special tax treatment and are taxed

at a maximum rate of 15%

#48

The $9,000 of interest is paid to produce $7,200 of taxable income and $800 of tax-exempt income

The portion of the interest related to the production of the tax-exempt income is not deductible$900 [$9,000 x ($800 ÷ $8,000)] of the interest is not

deductible Their investment interest expense is $8,100 ($9,000 -

$900) Because this amount exceeds their investment

income, their investment interest deduction is limited to $3,200

The remaining $4,900 ($8,100 - $3,200) is carried forward to 2012

#48

2012: Investment income: $2,900 ($1,400 + $1,500) Interest received on the municipal bonds is tax-

exempt Not allowed for purposes of computing allowable

investment interest deduction Dividends and net long-term capital gain cannot be

used in the calculation of gross investment income because it will be taxed at 15%

#48

The $5,000 of interest is paid to produce $5,600 of taxable income and $800 of tax-exempt income

The portion of the interest related to the production of the tax-exempt income is not deductible$625 [$5,000 x ($800 ÷ $6,400)] of the interest is not

deductible Their investment interest expense is $4,375 ($5,000 -

$625) Because $4,375 exceeds their investment income,

their investment interest deduction is limited to $2,900

The remaining $1,475 ($4,375 - $2,900) along with the $4,900 from 2011 is carried forward to the following year Total carryforward to 2013 is $6,375 ($4,900 + $1,475)

#48

Miguel is a successful businessman who has been approached by St. Kilda University to make a donation to its capital campaign. He agrees to contribute $75,000, but he is unsure which of the following assets he should contribute:

Asset Basis FMVOrdinary income property $ 41,000 $ 75,000Long-term capital gain property 84,000 75,000Long-term capital gain property 32,000 75,000

Write a letter to Miguel advising him which property he should contribute to St. Kilda’s capital campaign.

#52

Ordinary income property:The amount of the contribution is limited to the lesser

of: 1. the property’s fair market value at the date of the gift 2. the property’s adjusted basis

Appreciation in the value of ordinary income property is not allowed as a deduction

Limited to a maximum deduction of 50% of AGI

#52

Long-term capital gain property:FM valuation allowedAppreciation in the value of a long-term capital gain

property is allowed as a deductionAny property valued at fair market value is limited to

a maximum deduction of 30% of AGIThe taxpayer can elect to treat the long-term capital

gain property as ordinary income property (valuing property at it’s adjusted basis) and be subject to the 50% limitation

Any amounts in excess of the limits are carried forward

#52

If Miguel contributes the ordinary income property, his charitable contribution is limited to his basis in the property ($41,000)

Contributing either long-term capital gain property results in a charitable contribution of $75,000

If he contributes the capital gain property with a basis of $84,000, Miguel loses the benefit of being able to recognize the $9,000 ($75,000 - $84,000) loss

If he contributes the capital gain property with a basis of $32,000, he does not recognize the $44,000 ($75,000 - $32,000) gain on its appreciation

#52

Miguel should contribute the long-term capital gain property that has a basis of $32,000

#52

Alternative solution: If Miguel wants to contribute the long-term capital

gain property with a basis of $84,000, he could sell the property and realize the $9,000 loss

He will recognize a $3,000 capital loss in the current year

The amount of his donation to St. Kilda is $75,000 Instead of receiving property, St. Kilda would receive

cash

#52

Edna works as a marketing consultant. In her spare time, she enjoys painting. Although she sells some of her work at local craft shows, she either displays most of her paintings at home or gives them to family and friends. During the year, she receives $750 from the sale of her paintings. The cost of producing the sold paintings and the cost of attending the crafts shows is $1,850. Edna has other allowable miscellaneous deductions of $1,400, and her adjusted gross income before considering her painting activity is $48,000. Write a letter to Edna explaining her allowable miscellaneous itemized deduction for the year.

#55

Edna must include the $750 from the sale of the paintings in her gross incomeDeduction of hobby expenses is limited to the $750 of

income Hobby expenses are deducted as a

miscellaneous itemized deduction Subject to the 2% of AGI limitation

#55

Edna’s AGI after considering the income from her paintings is $48,750 ($48,000 + $750)

Total miscellaneous itemized deduction is $2,150 ($1,400 + $750)

$2,150 is reduced by the 2% of AGI limitation on miscellaneous itemized deductions: 

Total miscellaneous itemized deductions$2,150

Less: $48,750 x 2% (975)Allowable miscellaneous itemized deduction$1,175

#55

Michael owns a hair salon. During the current year, a tornado severely damages the salon and destroys his personal automobile, which is parked outside. It costs Michael $12,000 to make the necessary repairs to the salon. He had paid $21,500 for the automobile, which was worth $17,100 before the tornado. Michael’s business insurance reimburses him for $7,000 of the salon repair costs. His automobile insurance company pays only $12,000 for the automobile destruction. Michael’s adjusted gross income is $34,000 before considering the eff ects of the tornado. Write a letter to Michael explaining his deductible loss from the tornado.

#57

The damage to the hair salon is a business casualty, which is deductible for adjusted gross income

The deductible loss is $5,000$12,000 cost of repairing the salon less $7,000

insurance reimbursement

#57

The loss on the automobile is a personal casualty loss, which is deductible as an itemized deduction

The amount of the loss is the lesser of:1. $21,500 basis2. $17,100 decline in value

The $5,100 unreimbursed personal casualty loss ($17,100 - $12,000) is reduced by the $100 statutory fl oor

Total casualty loss for the year is subject to 10% of AGI

Michael’s adjusted gross income is $29,000 ($34,000 - $5,000 business casualty loss from the salon)

The $5,000 allowable personal casualty loss is reduced by $2,900 ($29,000 x 10%)Casualty loss deduction is $2,100

#57

Amount of loss $ 17,100Less: Insurance reimbursement (12,000)Less: Statutory fl oor (100)Allowable loss before 10% of AGI limitation $ 5,000Less: Annual loss limitation (10% x $29,000)

(2,900)Deductible casualty loss $ 2,100

#57

Rebecca and Irving incur the fol lowing medical expenses during the current year:Medical insurance premiums $4,100Hospital 950Doctors 1,225Dentist 575Veterinarian 170Chiropractor 220Cosmetic surgery 1,450Over-the-counter drugs 165Prescript ion drugs 195Crutches 105 They receive $4,000 in reimbursements from their insurance company of which $300 is for the cosmetic surgery. What is their medical expense deduction i f:

a. Their adjusted gross income is $44,000?

EXTRA PROBLEMS—#36

Medical insurance premiums $4,100Hospital 950Doctors 1,225Dentist 575Veterinarian 170Chiropractor 220Cosmetic surgery 1,450Over-the-counter drugs 165Prescription drugs 195Crutches 105

EXTRA PROBLEMS—#36

No

No

No

Medical insurance premiums $ 4,100Hospital 950Doctors 1,225Dentist 575Chiropractor 220Prescription drugs 195Crutches 105Total Allowable medical expenses $ 7,370

EXTRA PROBLEMS—#36

Reimbursed medical costs:Insurance reimbursement: $4,000Reimbursement for cosmetic surgery: $300Reimbursement related to medical expense

deduction: $3,700The $3,670 of medical expenses is subject to the

7.5% AGI limitation

EXTRA PROBLEMS—#36

Medical insurance premiums $ 4,100Hospital 950Doctors 1,225Dentist 575Chiropractor 220Prescription drugs 195Crutches 105Total Allowable medical expenses $ 7,370Less: Insurance reimbursements (3,700)Unreimbursed medical expenses $ 3,670Less: AGI limitation ($44,000 x 7.5%) (3,300)Medical expense deduction $ 370

EXTRA PROBLEMS—#36

b. Their adjusted gross income is $61,000?

No deduction is allowedThe AGI limit is $4,575 ($61,000 x 7.5%), which

is greater than their $3,670 of unreimbursed costs

EXTRA PROBLEMS—#36

Arthur and Cora are married and have 2 dependent children. They have a gross income of $95,000. Their allowable deductions for adjusted gross income total $4,000, and they have total allowable itemized deductions of $14,250.

a. What is Arthur and Cora’s taxable income?

EXTRA PROBLEMS—#35

Gross income $ 95,000Deductions for AGI (4,000)Adjusted gross income $ 91,000Deductions from AGI:The greater of:

Itemized deductions $ 14,250or

Standard deduction $ 11,900(14,250) Personal & dependency exemptions (4 x $3,800) (15,200)Taxable income $ 61,550

EXTRA PROBLEMS—#35

b. What is Arthur and Cora’s income tax?

$1,740 + [15% x ($61,550 - $17,400)] =$ 8,363Less: Child tax credit (2 x $1,000) (2,000)

Net tax liability $ 6,363

EXTRA PROBLEMS—#35

c. If Arthur has $2,900 and Cora has $3,800 withheld from their paychecks, are they entitled to a refund, or do they owe additional taxes?

They are entitled to a refund of $337 [$6,363 - ($2,900 + $3,800)]

EXTRA PROBLEMS—#35