Chapter 7 Reductions And Losses: Study Guide
CHAPTER 7 DEDUCTIONS AND LOSSES: CERTAIN BUSINESS EXPENSES AND LOSSES SOLUTIONS TO PROBLEM MATERIALS
Question/ Problem 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28
Learning Objective LO 1 LO 1 LO 1 LO 1 LO 1 LO 1 LO 1 LO 2 LO 2 LO 3, 4 LO 3, 4 LO 4 LO 4 LO 4 LO 4 LO 4 LO 4 LO 4 LO 4 LO 4 LO 3, 4 LO 5 LO 5 LO 6 LO 6 LO 6 LO 7 LO 7
Topic Bad debts: accounts receivable Bad debts: basis Bad debts: worthlessness Bad debts: recovery Bad debts: business Bad debts: business Worthless securities versus theft loss Worthless securities versus bad debts Section 1244 stock Casualty loss versus business loss Casualty loss Casualty loss: timing Casualty loss: reimbursement Casualty loss: measurement rule for theft Casualty …show more content…
loss: insurance claim Casualty loss: cost of repairs method Casualty loss: rental property Casualty loss: miscellaneous itemized deductions Casualty loss: 10% of AGI floor Casualty loss: occurrence Casualty loss: occurrence Research expenditures Research expenditures Research expenditures Domestic production activities deduction (DPAD): tax benefit Domestic production activities deduction (DPAD): NOL effect Net operating loss: definition Net operating loss: unreimbursed employee business expense 7-1
Status: Present Edition New Unchanged Unchanged Modified Unchanged Unchanged Unchanged Unchanged Modified Modified Unchanged Unchanged Unchanged New Unchanged Unchanged Modified Unchanged New Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Modified New
Q/P in Prior Edition 2 3 4 5 6 7 8 9 10 11 12 13 15 16 17 18 20 21 22 23 24 25 26 27 28
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2013 Individual Income Taxes/Solutions Manual Status: Present Edition Unchanged Unchanged Unchanged Unchanged Modified Unchanged Modified Unchanged Modified Unchanged Modified Unchanged Modified Modified Unchanged Q/P in Prior Edition 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43
Question/ Problem 29 30 31 32 33 34 *35 *36 *37 *38 *39 *40 *41 42 43
Learning Objective LO 7 LO 7
Topic
44
45 46
*47 *48 *49 *50 *51 52 *53 *54 *55
Net operating loss: itemized deductions Net operating loss: effect of carryback on charitable contribution LO 7 Net operating loss: calculation and carryback LO 1 Bad debts: nonbusiness LO 1 Bad debts: nonbusiness LO 1 Bad debts: business LO 1, 2 Bad debt and § 1244 stock and capital loss limit LO 2, 8 Section 1244 stock LO 4 Casualty loss: personal and business LO 3, 4, 8 Casualty loss: disaster area loss LO 3, 4 Casualty loss: business versus personal use property LO 3, 4 Casualty loss: insurance recovery LO 5 Research expenditures LO 6 Domestic production activities deduction (DPAD) LO 6 Domestic production activities deduction (DPAD): qualified production activities income (QPAI) and AGI for individual LO 6 Domestic production activities deduction (DPAD): qualified production activities income (QPAI) and NOL LO 6 Domestic production activities deduction (DPAD): qualified production activities income (QPAI) LO 6 Domestic production activities deduction (DPAD): qualified production activities income (QPAI) and W-2 wage limit LO 7 Net operating loss: calculation LO 7 Net operating loss: calculation LO 7 Net operating loss: calculation, recomputed taxable income, and remaining NOL LO 7 Net operating loss: calculation for farming business LO 7 Net operating loss: carryover for farming business LO 7 Net operating loss: farming business LO 7 Net operating loss: carryover LO 7 Net operating loss: calculation and carryover LO 1, 2, 7 Net operating loss and § 1244 stock: calculation
Modified
44
Unchanged Unchanged
45 46
Updated Modified Updated Updated Updated Unchanged Updated Updated Modified
47 48 49 50 51 52 53 54 55
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Deductions and Losses: Certain Business Expenses and Losses Status: Present Edition Unchanged Unchanged Unchanged Unchanged Modified New
7-3 Q/P in Prior Edition 56 57 58 59 60
Question/ Problem *56 *57 *58 *59 *60 *61
Learning Objective LO 1, 3
Topic
AGI computed with bad debts and net capital loss LO 1, 4 AGI computed with bad debts and personal casualty gain LO 1, 4, 7 Net operating loss and personal casualty loss LO 1, 2, Net operating loss, § 1244 stock, and 3, 4, 7 personal casualty loss Cumulative Cumulative
*The solution to this problem is available on a transparency master. Status: Present Edition Unchanged Unchanged Unchanged New Unchanged Unchanged Unchanged Q/P in Prior Edition 1 2 3 5 6 7
Research Problem 1 2 3 4 5 6 7
Topic Bad debts Net operating loss Casualty or theft loss Casualty loss deduction Casualty loss deduction Internet activity Internet activity
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2013 Individual Income Taxes/Solutions Manual CHECK FIGURES
32. 33. 34. 35. 36. 37. 38. 39. 40. 41.a. 41.b. 42. 43. 44. 45. 46. 47.a. 47.b. 48.a. 48.b.
In the year of complete worthlessness. Include $7,000 in gross income. $5,000 bad debt deduction. Negative $17,000. Mary should sell half each year. $53,000 AGI, $33,940 deduction. $60,000 loss should be taken currently. AGI of $75,000; $37,400 itemized deduction. Net cash benefit of $7,800 of filing an insurance claim. 2012 $619,000; 2013 $703,000; 2014 $0. 2012 $0; 2013 $0; 2014 $132,198. $30,000. $49,500. $90,000. $5 ($6 – $1). $200,000. ($13,750). No NOL. ($46,400). NOL of $35,000.
49.a. 49.b. 49.c. 50.a. 50.b. 50.c. 50.d. 51.a. 51.b. 52.a. 52.b. 52.c. 53. 54.a. 54.b. 54.c. 55.a. 55.b. 56. 57. 58. 59. 60. 61.
$33,000. $0. $3,900. ($85,600). $75,000. $75,000. Back 5 years and forward 20 years. $0. $62,725. ($83,600). ($70,000). ($50,000). $4,450. ($24,500). No NOL. $16,900 NOL carryforward. NOL of $19,000. 2-year carryback. $48,000. $55,000. Taxable income ($17,000); NOL $0. $79,900. Refund due for 2011 $1,142. Refund due for 2012 $2,130.
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Deductions and Losses: Certain Business Expenses and Losses DISCUSSION QUESTIONS 1. 2. 3. 4.
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An account receivable can give rise to a bad debt deduction if income arising from the creation of the account receivable was previously included in gross income. p. 7-3 Mike’s basis in the receivable would be the $7,000 ($10,000 × 70%) he paid for the receivable. Therefore, if he collects $6,000, he will have a bad debt of $1,000 ($7,000 – $6,000). p. 7-4 A loss is deductible only in the year of total worthlessness for a nonbusiness bad debt and is classified as a short-term capital loss. pp. 7-4 and 7-5 Jane must include the $5,000 in gross income of the current tax year, but only to the extent of the tax benefit in the previous year. Because Jane had capital gains of $2,000 in the previous year, the $50,000 bad debt could be used to the extent of $5,000 ($2,000 + $3,000) last year. Hence, Jane would have to include the $5,000 received in gross income in the current year. p. 7-4 The non-collection of an account would be considered a business bad debt. As such, it would be deducted as an ordinary loss in the year incurred. A business bad debt can be deducted based on either partial worthlessness or complete worthlessness. However, the amount of the deduction is limited to Bob’s basis in the account (what he paid for the account), not its face value. pp. 7-4 and 7-5 The business bad debt is treated as an ordinary loss and hence, the fact that the business has long-term capital gains has no relevance. pp. 7-4 and 7-5 Jack should be concerned with the following issues: • • Should this be treated as a worthless security? Should this be treated as a theft loss? • • Does the theft loss create an NOL? Can the NOL be carried back 3 years?
5.
6. 7.
pp. 7-6 and 7-20 8. Sean cannot take the loss as a business bad debt because a bond is a security. Sean cannot take the loss as a worthless security because losses are allowed only when the security is completely worthless. p. 7-6 The gain on the sale of § 1244 stock is treated as a capital gain. pp. 7-6 and 7-7 Some courts have held that termite damage over periods of up to 15 months after infestation constituted a sudden event and was, therefore, deductible as a casualty loss. However, the current position of the IRS is that termite damage is not deductible. p. 7-8 Casualty losses are not allowed for a decline in the value of the property. Losses are allowed only for actual damage. p. 7-8 Generally, a casualty loss is deducted in the year the loss occurs. However, no casualty loss is permitted if a reimbursement claim with a reasonable prospect of full recovery exists. If the taxpayer has a partial claim of recovery, only part of the loss can be claimed in the year
9. 10.
11. 12.
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2013 Individual Income Taxes/Solutions Manual of the casualty, and the remainder is deducted in the year the claim is settled. pp. 7-9 and 7-10
13.
Mary should include the recovery as gross income in her 2012 tax return, but only to the extent of the tax benefit in the prior year. Mary’s deduction in the prior year would have been $3,900 computed as follows: Amount of loss Less: $100 floor 10% × 40,000 Deduction $8,000 (100) (4,000) $3,900
Therefore, Mary must include $3,900 in gross income in 2012. pp. 7-9 to 7-12 14. 15. The amount of the loss is the adjusted basis of the property for the theft of property used in a transaction entered into for profit. pp. 7-11 and 7-14 A taxpayer is not permitted to deduct a casualty loss for damage to insured personal use property unless a timely insurance claim is filed with respect to the damage to the property. If the taxpayer does not file an insurance claim, the loss must be reduced by the proceeds that could have been received from the insurance company. pp. 7-11 and 7-12 The cost of repairs can be used as a method for measuring the amount of a casualty loss if the repairs are necessary to restore the property to its condition before the casualty, the amount spent for the repairs is not excessive, and the repairs do not extend beyond the damage suffered. In addition, the value of the property after the repairs must not, as a result of the repairs, exceed the value of the property immediately before the casualty. p. 7-12 The property has been completely destroyed. Hence, the amount of the loss is $650,000 (the adjusted basis). p. 7-11 If the painting is treated as personal use property, the amount of the loss is limited to $40,000 and is subject to the $100 and 10%-of-AGI floors. However, if the painting is treated as investment property, the loss is $50,000 and is treated as an other miscellaneous itemized deduction and not subject to the 2%-of-AGI floor. Hence, all of the $50,000 could be taken as a deduction. pp. 7-11 and 7-12 If personal casualty gains exceed personal casualty losses, the gains and losses are treated as gains and losses from the sale of capital assets. The holding period depends on the period the taxpayer held each asset. pp. 7-14 and 7-15 Kelly should be concerned with the following issues: • • • Is this a theft loss? What is the amount of the loss? In which year can the loss be taken?
16.
17. 18.
19.
20.
pp. 7-9 to 7-12 21. The tax issues for John are as follows: • Is the loss a theft loss or an investment loss?
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Deductions and Losses: Certain Business Expenses and Losses • •
7-7
Is the loss subject to either the personal loss limits ($100 floor and 10%-of-AGI floor) or the limits on itemized deductions (2%-of-AGI floor)? How is the amount of the loss determined?
pp. 7-9 to 7-12 22. These modification costs should be capitalized and thus increase the basis of the building. The depreciation on the portion of the building used for research is a research and experimental expenditure. pp. 7-16 and 7-17 Research and experimental expenditures are usually amortized rather than expensed when a company does not have sufficient income to offset the expenses. pp. 7-16 and 7-17 The tax issues for Silver, Inc. are as follows: • Is the extraction and processing of silver ore a manufacturing activity? • • Can the deduction be taken for prior years? What laws will apply for prior years?
23. 24.
pp.
7-18 to 7-20 25. DPAD is a deduction that is determined in a unique manner. Unlike most deductions that are generated by expenditures, DPAD is based on income. If certain production activities produce a profit, DPAD is a percentage of that profit. Consequently, the larger the profit, the larger the deduction. Of course, the profit increases the income tax, while the deduction reduces the income tax. pp. 7-18 to 7-20 The taxable income limitation on the DPAD is determined after the application of any NOL deduction. Thus, a company with an NOL carryforward for a tax year is ineligible for the DPAD in the current year if the NOL carryforward eliminates current taxable income. A taxpayer that has an NOL carryback may lose part or all of the DPAD benefit for the tax year to which the NOL is applied. pp. 7-18 and 7-19 An unreimbursed employee business expense which is an itemized deduction is a business expense and hence, can create or increase an NOL for an individual taxpayer. p. 7-23 Individual Retirement Account deductions and alimony paid deductions are deductions for AGI. However, they are treated as nonbusiness deductions in computing an individual’s NOL. p. 7-23 Itemized deductions for personal casualty and theft losses and losses incurred in a transaction entered into for profit can create an NOL. p. 7-21 The AGI will be reduced by the NOL carryback, but this will not change the limit for the charitable contribution deduction in the carryback year. pp. 7-21 and 7-23 The tax issues for Thomas are as follows: • Are the following items trade or business deductions and hence, deductible in computing an
NOL?
26.
27. 28.
29. 30. 31.
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7-8 • • •
2013 Individual Income Taxes/Solutions Manual Alimony payments. Moving expenses. Contributions to a traditional IRA.
pp. 7-19 to 7-23 PROBLEMS 32. Hoffman and Smith, CPAs 5191 Natorp Boulevard Mason, OH 45040 January 29, 2012 Mr. John Johnson 100 Tyler Lane Erie, PA 16563 Dear Mr. Johnson: This letter is to inform you of the possibility of taking a bad debt deduction. Your loan to Sara is a nonbusiness bad debt; therefore, you are not allowed to take a bad debt deduction for partial worthlessness. You will be able to take a bad debt deduction in the year in which the debt becomes wholly worthless. Should you need more information or need to clarify anything, please contact me. Sincerely, John J. Jones, CPA Partner TAX FILE MEMORANDUM January 29, 2012 From: Subject: John J. Jones Bad Debt Deduction
John Johnson’s $30,000 loan to Sara is a nonbusiness bad debt. Therefore, a bad debt deduction is not allowed for partial worthlessness. John will be able to claim a bad debt deduction in the year when the debt becomes wholly worthless. pp. 7-3 to 7-5 33. Monty must include up to $10,000 in gross income, but only to the extent of a tax benefit in a prior year. Because the debt is a nonbusiness bad debt, the $11,000 would have been reported as a short-term capital loss. Last year, Monty had capital gains of $4,000 and taxable
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Deductions and Losses: Certain Business Expenses and Losses
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income of $20,000. Therefore, $7,000 of the $11,000 loss produced a tax benefit. Hence, only $7,000 would be included in Monty’s gross income this year. pp. 7-3 and 7-4 34. The potential bad debt is limited to Sally’s basis in the debt. Because she paid $60,000 for the account and collected $55,000, she has a bad debt of $5,000 ($60,000 – $55,000). pp. 7-4 and 7-5 Salary § 1244 ordinary loss (limit of $100,000) Short-term capital gain on § 1244 stock Short-term capital loss (nonbusiness bad debt) Net short-term capital gain Net long-term capital loss (remaining § 1244 loss) Net capital loss (limit) Adjusted gross income pp. 7-6 and 7-7 36. Sell all of the stock in the current year: Current year’s AGI Salary Ordinary loss (§ 1244 limit) Long-term capital gain Long-term capital loss ($80,000 – $50,000) Long-term capital loss (limit) AGI Next year’s AGI Salary Long-term capital gain Long-term capital loss carryover ($30,000 – $11,000) Long-term capital loss (limit) AGI Total AGI Current year Next year Total Sell half of the stock this year and half next year: Current year’s AGI Salary Ordinary loss (§ 1244 stock) Long-term capital gain AGI Next year’s AGI Salary Ordinary loss (§ 1244 stock) Long-term capital gain AGI $ 80,000 (40,000) 8,000 $ 48,000 $ 90,000 (40,000) 10,000 $ 60,000 $ 80,000 (50,000) (3,000) $ 27,000 $ 90,000 (3,000) $ 87,000 $ 27,000 87,000 $114,000 $120,000 (100,000)
35.
$20,000 (19,000) 1,000 (5,000)
(3,000) $ 17,000
$8,000 (30,000)
$10,000 (19,000)
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7-10 Total AGI Current year Next year Total
2013 Individual Income Taxes/Solutions Manual
$ 48,000 60,000 $108,000
Mary’s combined AGI for the two years is lower if she sells half of her § 1244 stock this year and half next year. p. 7-6 37. AGI before adjustment Adjustment ($11,000 gain on silverware – $8,000 loss on cash stolen) AGI Bearer bonds loss Miscellaneous itemized deduction for computer [$5,000 – 2%($53,000)] Total deduction pp. 7-7 to 7-13 38. The loss is a business loss. Therefore, for the farm building and the farm equipment that were completely destroyed, the adjusted basis is used in calculating the amount of the casualty loss. For the barn that was damaged, the lower of the adjusted basis or the decline in value is used in calculating the amount of the casualty. Building ($90,000 – $70,000) Equipment ($40,000 – $25,000) Barn ($50,000 – $25,000) Total loss $20,000 15,000 25,000 $60,000 $50,000 3,000 $53,000 $30,000 3,940 $33,940
Because the President declared the area a disaster area, Olaf and Anna could claim the loss on last year’s return or on the current year’s tax return. If Olaf applies the loss to the prior year, the benefit of the loss will be at a tax rate of 28%. If the loss is applied to the current year, the benefit will be at a tax rate of 33% rather than 28% and thus, provide a tax savings of $19,800 ($60,000 × 33%) rather than $16,800 ($60,000 × 28%). Olaf should include the loss on the current year’s tax return, since the tax savings is $3,000 ($19,800 – $16,800) greater. pp. 7-7 to 7-13 39. Cost Depreciation Adjusted basis Loss on building: Loss ($900,000 – $200,000) Less: Insurance reimbursement Loss (gain) Total $800,000 (100,000) $700,000 $700,000 $600,000 Business Portion (40%) $320,000 (100,000) $220,000 $220,000* (240,000) ($ 20,000) Personal Portion (60%) $480,000 (–0–) $480,000 $420,000 (360,000) $ 60,000
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Deductions and Losses: Certain Business Expenses and Losses Business contents loss Less: Insurance recovery Loss Personal casualty gain—contents ($ 65,000 insurance proceeds – $50,000 adjusted basis) Personal casualty loss—building AGI before effects of accident Business gain—building Business loss—contents Personal casualty gain Personal casualty loss to extent of gain AGI Personal casualty loss—building ($60,000 – $15,000 – $100) Less: 10% of AGI floor (10% × $75,000) Itemized deduction $220,000 (175,000) $ 45,000 $ 15,000 ($ 60,000) $100,000 20,000 (45,000) 15,000 (15,000) $ 75,000 ($ 44,900) 7,500 ($ 37,400)
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*Adjusted basis is less than the decline in FMV of $280,000 ($700,000 × 40%). pp. 7-7 to 7-15 40. Hoffman and Smith, CPAs 5191 Natorp Boulevard Mason, OH 45040 January 26, 2012 Mr. Sam Smith 450 Colonel’s Way Warrensburg, MO 64093 Dear Mr. Smith: This letter is to inform you of the tax and cash flow consequences of filing a claim versus not filing a claim with your insurance company for reimbursement for damages to your business use car. If an insurance claim is filed, you will have a taxable gain of $2,000 computed as follows: Insurance recovery Less: Lesser of adjusted basis of $10,000 or decline of FMV of $12,000 Gain This will produce a net cash flow of $11,300 computed as follows: Insurance reimbursement received Less: Tax on gain (35% × $2,000) Net cash flow $12,000 (700) $11,300 $12,000 (10,000) $ 2,000
If no insurance claim is filed, you will have a deductible loss of $10,000 which will reduce your tax liability by $3,500 (35% × $10,000).
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2013 Individual Income Taxes/Solutions Manual The net cash benefit resulting from filing an insurance reimbursement claim would be $7,800 ($11,300 – $3,500). Should you need more information or need to clarify anything, please contact me. Sincerely, John J. Jones, CPA Partner TAX FILE MEMORANDUM January 26, 2012 From: Subject: John J. Jones Tax consequences for Sam Smith if he does not file an insurance claim for reimbursement for damages to his business use car.
If an insurance claim is filed, Sam will have a taxable gain of $2,000 computed as follows: Insurance recovery Less: Lesser of adjusted basis of $10,000 or decline of FMV of $12,000 Gain This will produce a net cash flow of $11,300 computed as follows: Insurance reimbursement received Less: Tax on gain (35% × $2,000) Net cash flow $12,000 (700) $11,300 $12,000 (10,000) $ 2,000
If no insurance claim is filed, Sam will have a deductible loss of $10,000 which will reduce his tax liability by $3,500 (35% × $10,000). In my correspondence with Sam, I pointed out the net cash benefit from filing an insurance reimbursement claim would be $7,800 ($11,300 − $3,500). pp. 7-11 to 7-15 41. a. 2012 Salaries Materials Insurance Utilities Equipment depreciation Total expenses $500,000 90,000 8,000 6,000 15,000 $619,000
Cost of inspection of materials for quality control ($7,000), promotion expenses ($11,000), and cost of market survey ($8,000) are not included as research and experimental expenditures. 2013 Salaries Materials $600,000 70,000
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Deductions and Losses: Certain Business Expenses and Losses Insurance Utilities Equipment depreciation Total expenses 11,000 8,000 14,000 $703,000
7-13
Cost of inspection of materials for quality control ($6,000), advertising ($20,000), and promotion expenses ($18,000) are not included as research and experimental expenditures. 2014 No deduction based on data provided. b. The research and experimental expenditures are amortized over a 60-month period beginning with the month in which the taxpayer first realizes benefits from the experimental expenditures (i.e., July 2014 for Blue Corporation). The monthly amortization is $22,033 ($1,322,000 ÷ 60). 2012 No deduction for research and experimental expenditures. 2013 No deduction for research and experimental expenditures. 2014 Deduction for research and experimental expenditures: $22,033 × 6 months = $132,198 pp. 7-16 and 7-17 42. 43. 44. Sarah’s DPAD is $30,000 [9% × $350,000 (the smaller of $350,000 modified AGI or $400,000 QPAI)] [not to exceed $30,000 (50% × $60,000 of W-2 wages)]. pp. 7-18 to 7-20 Barbara’s DPAD in 2012 is $49,500 [9% × $550,000 (the smaller of $600,000 AGI and $550,000 QPAI)]. pp. 7-18 and 7-19 Red Corporation’s taxable income for the year is $1,200,000 ($2,000,000 – $800,000 NOL). This is not less than the QPAI ($1,000,000) and hence, the QPAD is $90,000 (9% × $1,000,000). This assumes the QPAD is not limited by W-2 wages. pp. 7-18 and 7-19 The QPAI for a skirt is $6 ($12 – $5 – $1). The QPAI for a blouse is a negative $1 ($10 – $6 – $5). Green must net the two items to arrive at the QPAI of $5 ($6 – $1). pp. 7-18 and 7-19 The DPAD is $200,000 (50% × $400,000 associated W-2 wages) which is less than $270,000 (9% × $3,000,000). Because the wage base limits the deduction, Rose may want to outsource less of its work. pp. 7-18 and 7-19 a. Business income Business expenses Net business income Interest income Alimony paid AGI Less: Standard deduction Personal exemption $70,000 (65,000) $ 5,000 3,000 (12,000) ($ 4,000) (5,950) (3,800)
45. 46.
47.
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2013 Individual Income Taxes/Solutions Manual Taxable income b. Taxable income Add: Personal exemption Excess of nonbusiness deductions over nonbusiness income [($5,950 + $12,000) – $3,000] No NOL ($13,750) ($13,750) 3,800 14,950 $ 5,000
pp. 7-20 to 7-23 48. a. Business receipts Less: Business expenses Net business loss Alimony received Interest income Adjusted gross income Less: Itemized deductions Personal and dependency exemptions (3 × $3,800) Taxable income Taxable income Add: Personal and dependency exemptions Excess of nonbusiness deductions ($24,000) over nonbusiness income ($3,000 + $22,000) NOL $144,000 (180,000) ($ 36,000) 22,000 3,000 ($ 11,000) (24,000) (11,400) ($ 46,400) ($46,400) 11,400 –0– ($35,000)
b.
In calculating the NOL, the alimony received of $22,000 is not treated as business income. pp. 7-20 to 7-23 49. a. Business receipts Less: Business expenses Net business loss Salary Ordinary nonbusiness income Nonbusiness short-term capital gain $20,000 Nonbusiness long-term capital loss (9,000) Net short-term capital gain Adjusted gross income Less: Itemized deductions Personal exemptions (2 × $3,800) Taxable income Add: Excess of nonbusiness deductions over nonbusiness income and net nonbusiness capital gains [$18,000 – ($8,000 + $11,000)] $ –0– Personal exemptions (2 × $3,800) 7,600 Net operating loss for 2012 pp. 7-20 to 7-23 b. Net business income Interest income 2012 net operating loss Adjusted gross income $60,000 2,000 (33,000) $29,000 $276,000 (320,000) ($ 44,000) 10,000 8,000 11,000 ($ 15,000) (18,000) (7,600) ($ 40,600)
7,600 ($ 33,000)
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Deductions and Losses: Certain Business Expenses and Losses Less: Itemized deductions Charitable contribution is not affected by the NOL Medical expenses of $6,550, limited to the amount in excess of the new AGI ($6,550 – $2,175) Total itemized deductions Less: Personal exemptions (2 × $3,700) Recomputed taxable income for 2011 p. 7-24 c. Net business income Interest income Adjusted gross income Less: Itemized deductions Charitable contributions of $40,000, limited to 50% of new AGI* $31,000 Medical expenses of $6,550, limited to the amount in excess of 7.5% of new AGI* ($6,550 – $4,650) 1,900 Total itemized deductions Less: Personal and dependency exemptions (not allowed) Modified taxable income for 2011 Net operating loss for 2012 Less: Modified taxable income for 2011 Net operating loss to carry forward to 2013 $60,000 2,000 $62,000
7-15
$31,000 4,375
(35,375) (7,400) $ –0–
(32,900) (–0–) $29,100 $33,000 (29,100) $ 3,900
*Note: In this problem, the revised AGI is the same as the original AGI. If there had been a net capital loss deduction, it would have been eliminated as an adjustment and AGI would have increased. pp. 7-20 to 7-26 50. a. Business receipts from farming Less: Business expenses for farming Net business loss Interest income Salary Net capital gain Adjusted gross income Less: Itemized deductions Personal exemptions (2 × $3,800) Taxable income Taxable income Add: Personal exemptions Excess of nonbusiness deductions over nonbusiness income and nonbusiness capital gains: $400,000 (525,000) ($125,000) 8,000 50,000 4,000 ($ 63,000) (15,000) (7,600) ($ 85,600) ($ 85,600) $7,600
b.
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7-16
2013 Individual Income Taxes/Solutions Manual Itemized deductions Less: Interest income Capital gain Net operating loss $15,000 (8,000) (4,000)
3,000
10,600 ($ 75,000)
The farming loss is limited to $75,000 (the amount of the NOL). c. d. Rick and Sara’s NOL for 2012 is $75,000. Since the NOL relates to a farming loss, it can be carried back five years and forward 20 years.
pp. 7-20 to 7-26 51. a. Salary Capital loss 2012 net operating loss Adjusted gross income Less: Itemized deductions Charitable contributions are not affected by the NOL Medical expenses of $2,100, limited to the amount in excess of 7.5% of the new AGI ($2,100 – $0) Total itemized deductions Less: Personal exemptions (2 × $3,700) Recomputed taxable income for 2011 $25,000 (1,000) (75,000) ($51,000) $12,000 2,100
(14,100) (7,400) $ –0– $25,000 (–0–) $25,000
b.
Salary Capital loss (not allowed) Adjusted gross income Less: Itemized deductions Charitable contribution of $20,000, limited to 50% of new AGI $12,500 Medical expenses of $2,100, limited to the amount in excess of 7.5% of the new AGI ($2,100 – $1,875) 225 Total itemized deductions Less: Personal and dependency exemptions (not allowed) Modified taxable income for 2011 Net operating loss for 2012 Modified taxable income for 2011 Net operating loss to carry forward to 2013
(12,725) (–0–) $12,275 ($75,000) 12,275 ($62,725)
pp. 7-20 to 7-26 52. a. Farming income Less: Farming expenses Net farming loss Interest income Adjusted gross income Less: Itemized deductions ($20,000 + $12,000) Personal exemptions (2 × $3,800) Taxable income $300,000 (350,000) ($ 50,000) 6,000 ($ 44,000) (32,000) (7,600) ($ 83,600)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Deductions and Losses: Certain Business Expenses and Losses b. Taxable income Add: Personal exemptions Excess of nonbusiness deductions over nonbusiness income: Itemized deductions Less: Casualty loss Interest income Excess NOL c. d. ($ 83,600)
7-17
$7,600 $32,000 (20,000) $12,000 (6,000)
6,000
13,600 ($ 70,000)
The farming loss is $50,000 because it is less than the NOL of $70,000. The $50,000 farming loss can be carried back five years and forward 20 years. The remaining $20,000 ($70,000 – $50,000), which relates to the casualty loss, can be carried back three years and forward 20 years. pp. 7-20 to 7-26 Hoffman and Smith, CPAs 5191 Natorp Boulevard Mason, OH 45040
53.
February 6, 2012 Mr. and Ms. Robert Reid 201 Jerdone Avenue Conway, SC 29526 Dear Mr. and Ms. Reid: In response to your inquiry concerning the amount of net operating loss remaining if the 2012 loss of $30,000 is applied against the 2011 taxable income of $14,850, the amount of net operating loss remaining is $4,450, computed as follows: Salary Capital loss (not allowed) Adjusted gross income Less: Itemized deductions Charitable contribution of $24,000, limited to 50% of new AGI Medical expenses of $4,200, limited to the amount in excess of 7.5% of the new AGI ($4,200 – $3,750) Total itemized deductions Less: Personal exemptions (not allowed) Modified taxable income for 2011 Net operating loss for 2012 Modified taxable income for 2011 Net operating loss to carry forward to 2013 $50,000 (–0–) $50,000 $24,000 450
(24,450) (–0–) $25,550 ($30,000) 25,550 ($ 4,450)
Should you need more information or need to clarify anything, please contact me. Sincerely yours,
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
7-18
2013 Individual Income Taxes/Solutions Manual John J. Jones, CPA Partner TAX FILE MEMORANDUM February 1, 2012 From: Subject: John J. Jones Robert and Susan Reid’s net operating loss carryforward
If Robert and Susan Reid apply their 2012 NOL of $30,000 against their 2011 taxable income of $14,850, the remaining NOL to carry forward is $4,450, computed as follows: Salary Capital loss (not allowed) Adjusted gross income Less: Itemized deductions Charitable contribution of $24,000, limited to 50% of new AGI Medical expenses of $4,200, limited to the amount in excess of 7.5% of the new AGI ($4,200 – $3,750) Total itemized deductions Less: Personal exemptions (not allowed) Modified taxable income for 2011 Net operating loss for 2012 Modified taxable income for 2011 Net operating loss to carry forward to 2013 pp. 7-20 to 7-26 54. a. Salary Interest income 2011 NOL AGI Less: Standard deduction Personal exemptions (2 × $3,800) Taxable income Taxable income Add: Personal exemptions Excess of nonbusiness deductions over nonbusiness income ($11,900 – $5,000) 2011 NOL carryforward No NOL Salary Interest income AGI Less: Standard deduction Personal exemptions (not allowed) Modified taxable income $50,000 5,000 (60,000) ($ 5,000) (19,500) ($24,500) ($24,500) 7,600 6,900 60,000 $50,000 $50,000 5,000 $55,000 (11,900) (–0–) $43,100 $50,000 (–0–) $50,000 $24,000 450 (24,450) (–0–) $25,550 ($30,000) 25,550 ($ 4,450)
$11,900 7,600
b.
c.
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Deductions and Losses: Certain Business Expenses and Losses NOL Modified taxable income NOL carryforward pp. 7-20 to 7-26 55. a. Salary Interest income (taxable government bonds) Dividends Ordinary loss on § 1244 stock ($20,000 – $65,000) Business bad debt Short-term capital gains and losses Short-term capital gain ($4,000 – $800) Short-term capital loss (nonbusiness bad debt) Net short-term capital loss Long-term capital gains and losses Gain ($40,000 – $18,000) Loss Net long-term capital gain Net capital gain Adjusted gross income Less: Itemized deductions Personal exemption (1 × $3,800) Taxable income Add: Personal exemption Excess of nonbusiness deductions over nonbusiness income plus net nonbusiness capital gains Total itemized deductions $25,000 Less: Interest (2,000) Dividends (500) Net nonbusiness capital gain (20,200) Net operating loss for 2012 $30,000 2,000 500 (45,000) (4,000) $3,200 (5,000) ($1,800) $22,000 (–0–) $22,000 ($60,000) 43,100 ($16,900)
7-19
$ 3,800
20,200 $ 3,700 (25,000) (3,800) ($25,100)
2,300
6,100 ($19,000)
b.
Because this is a 2012 NOL, it is carried back 2 years to 2010.
pp. 7-4 to 7-7 and 7-19 to 7-22 56. Salary Interest income Business bad debt Nonbusiness bad debt (short-term capital loss) Short-term capital loss Total short-term capital loss Long-term capital gain Net short-term capital loss Capital loss limit Adjusted gross income pp. 7-4 and 7-5 $50,000 3,000 (2,000)
($6,000) (3,000) ($9,000) 4,000 ($5,000)
(3,000) $48,000
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7-20 57.
2013 Individual Income Taxes/Solutions Manual Salary Interest income Business bad debt Nonbusiness bad debt Short-term capital loss Total short-term capital loss Short-term capital gain* Net short-term capital gain Long-term capital gain Long-term capital loss* Net long-term capital gain Adjusted gross income $50,000 3,000 (2,000)
($6,000) (3,000) ($9,000) 10,000 $4,000 (1,000)
1,000 3,000 $55,000
*Personal casualty gains exceed personal casualty losses ($10,000 – $1,000 = $9,000); therefore, all personal casualty items are treated as capital gains and losses. pp. 7-3, 7-4, and 7-13 to 7-15 58. Salary Interest income Business bad debt Nonbusiness bad debt Short-term capital loss Total short-term capital loss Long-term capital gain Net short-term capital loss Capital loss limited to $3,000 Personal casualty gains* Personal casualty losses* Adjusted gross income Less: Itemized deductions Interest expense Casualty losses in excess of casualty gains ($61,000 – $10,000) Less: 10% AGI (10% × $48,000) Casualty loss Total itemized deductions Less: Personal exemption (1 × $3,800) Taxable income (loss) $50,000 3,000 (2,000)
($ 6,000) ( 3,000) ($ 9,000) 4,000 ($ 5,000)
(3,000) 10,000 (10,000) $48,000
$15,000 $51,000 (4,800)
46,200
(61,200) (3,800) ($17,000)
*Personal casualty losses exceed gains; therefore, all items are treated as ordinary items. Assume that a personal casualty loss means that the $100 floor already has been deducted. pp. 7-13 to 7-15 Taxable income Add: Personal exemption Excess of nonbusiness capital losses over nonbusiness capital gains to the extent included in taxable income Excess of nonbusiness deductions over nonbusiness income: Total itemized deductions Less: Casualty loss $3,800 3,000 $61,200 (46,200) ($17,000)
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Deductions and Losses: Certain Business Expenses and Losses Nonbusiness deductions Less: Interest income No loss p. 7-23 59. Salary State of Minnesota bond interest (Note 1) Ordinary § 1244 loss ($120,000 – $30,000) Long-term capital gain—land ($60,000 – $42,000) Long-term capital loss—worthless securities Net long-term capital gain Short-term capital loss—nonbusiness bad debt Net long-term capital gain Adjusted gross income Less: Itemized deductions Home mortgage interest Casualty loss—personal ($610,000 – $540,000) Less: $100 floor Less: 10% AGI floor Total itemized deductions Less: Personal exemptions (2 × $3,800) Taxable income (loss) Add: Personal exemptions Excess of nonbusiness deductions over the sum of nonbusiness income plus net nonbusiness capital gains ($14,000 – $3,000) (Note 2) Net operating loss Notes (1) (2) $15,000 (1,000)
7-21
14,000
($
20,800 –0–)
$80,000 –0– (90,000) $18,000 (5,000) $13,000 (10,000)
3,000 ($ 7,000)
$14,000 $70,000 (100) (–0–)
69,900
$ 7,600
(83,900) (7,600) ($98,500)
11,000
18,600 ($79,900)
The $40,000 of interest income from the State of Minnesota bonds is tax-exempt income. For this purpose, the personal casualty loss is treated as a business loss (i.e., is not classified as a nonbusiness deduction).
pp. 7-3 to 7-7, 7-11 to 7-13, 7-20, 7-21, and 7-23 CUMULATIVE PROBLEMS 60. Part 1— Tax Computation Salary and bonus ($100,000 + $1,000) Typing service business net receipts ($20,000 – $24,580) Interest income (Note 1) Life insurance proceeds (Note 2) Gift (Note 3) Bingo prize Alimony Nonbusiness bad debt (Note 4) $101,000 (4,580) 700 –0– –0– 100 10,000 (2,100)
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7-22
2013 Individual Income Taxes/Solutions Manual Adjusted gross income Less: Itemized deductions Home mortgage interest Charitable contributions Sales taxes Casualty loss: Lesser of adjusted basis of $14,000 or FMV of $15,000 $14,000 Less: Insurance proceeds (1,500) $12,500 Less: $100 floor (100) Less: 10% AGI floor (10,512) Total itemized deductions Less: Personal exemption Taxable income Tax on taxable income (from Tax Table) Less: Federal income tax withheld and estimated tax payments ($18,000 + $1,000) Net tax payable (or refund due) for 2011 See the tax return solution beginning on page 7-26 of the Solutions Manual. Notes (1) (2) (3) (4) The $800 interest on the City of Boca Raton bonds is tax-exempt. Life insurance proceeds of $60,000 payable as the result of the death of Jane’s sister are excludible from gross income. The $5,000 gift from Jane’s aunt is excludible from gross income. The $2,100 loss on the loan to her friend, Joan Jensen, is deductible as a nonbusiness bad debt (i.e., short-term capital loss). The loan is a bona fide loan. $105,120 $9,500 2,500 964
1,888
(14,852) (3,700) $86,568 17,858 (19,000) ($ 1,142)
Part 2— Tax Planning Salary and bonus Gross receipts from business Less: Office rent Supplies Utilities and telephone Wages Payroll taxes Equipment rentals Net business income Interest income Alimony Adjusted gross income Less: Itemized deductions Personal exemption Taxable income $26,000 $7,000 4,840 5,148 5,500 550 3,300 $101,000
(26,338)
(338) 700 10,000 $111,362 (16,764) $ 94,598
$12,964 3,800
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Deductions and Losses: Certain Business Expenses and Losses
7-23
Tax on $94,598 [$17,443 + .28($94,598 – $85,650)] $19,948 Less: Federal income tax withheld (18,000) Net tax payable (or refund due) $ 1,948 Jane would need to make estimated tax payments of $1,948 for 2012 because the Federal income tax withholdings are expected to be less than the tax liability. Hoffman and Smith, CPAs 5191 Natorp Boulevard Mason, OH 45040 January 26, 2012 Ms. Jane Smith 2020 Oakcrest Road Boca Raton, FL 33431 Dear Ms. Smith: This letter is in response to your request concerning the minimum amount of estimated tax you will have to pay for 2012 so that you will not have to pay any additional tax upon filing your 2012 Federal income tax return. Based on the 2012 estimates you provided to us, we have determined that your estimated tax payments for the 2012 calendar year should total $1,948. This estimate is based on the following computation. Salary and bonus Gross receipts from business Less: Office rent Supplies Utilities and telephone Wages Payroll taxes Equipment rentals Net business income Interest income Alimony Adjusted gross income Less: Itemized deductions Personal exemption Taxable income Tax on $94,598 Less: Federal income tax withheld Net tax payable (or refund due) $26,000 $7,000 4,840 5,148 5,500 550 3,300 $101,000
(26,338)
(338) 700 10,000 $111,362 (16,764) $ 94,598 $ 19,948 (18,000) $ 1,948
$12,964 3,800
Should you need more information or need to clarify anything, please contact me. Sincerely yours, John J. Jones, CPA Partner
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7-24
2013 Individual Income Taxes/Solutions Manual TAX FILE MEMORANDUM January 10, 2012 From: Subject: John J. Jones Jane Smith’s 2012 estimated tax
Today I talked with Jane Smith concerning her 2012 estimated tax. She wanted to know the minimum amount of estimated tax she would have to pay for the calendar year 2012 so that she would not have to pay any additional tax upon filing her 2012 Federal income tax return. The following projections for 2012 were provided by Jane Smith: Items remaining unchanged from 2011: Salary—$50,000 Christmas bonus—$1,000 Itemized deductions—$12,964 Interest income—$700 Alimony—$10,000 Gross receipts from typing services—$26,000 Office rent will remain unchanged—$7,000 All other expenses for typing services will increase 10% from 2011: Supplies—$4,400 in 2011; $4,840 in 2012 Utilities and telephone—$4,680 in 2011; $5,148 in 2012 Wages—$5,000 in 2011; $5,500 in 2012 Payroll taxes—$500 in 2011; $550 in 2012 Equipment rentals—$3,000 in 2011; $3,300 in 2012 The following 2011 items will not recur in 2012: Life insurance proceeds—$60,000 Gift—$5,000 Bingo winnings—$100 Bad debt—$2,100 Stolen silverware Based on these estimates for 2012, Jane Smith should make 2012 estimated tax payments totaling $1,948. The determination was made as follows: Salary and bonus Gross receipts from business Less: Office rent Supplies Utilities and telephone Wages Payroll taxes Equipment rentals Net business income Interest income Alimony Adjusted gross income $26,000 $7,000 4,840 5,148 5,500 550 3,300 $101,000
(26,338)
(338) 700 10,000 $111,362
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Deductions and Losses: Certain Business Expenses and Losses Less:
7-25
Itemized deductions Personal exemption Taxable income Tax on $94,598 Less: Federal income tax withheld Net tax payable (or refund due) 61. Salary Rental income Less: Rental expenses Casualty loss on rental property Bad debt on uncollected rent (Note 1) Rent collected from prior year (Note 2) Ordinary loss on § 1244 stock (Note 3) Short-term capital loss—limit (Note 4) AGI Less: Itemized deductions Personal casualty loss Less: $100 floor Less: 10% AGI Loss on investment property (painting) Loss on computer Less: 2% AGI Other itemized deductions Less: Personal exemptions (2 × $3,800) Taxable income Tax on $8,700 (Note 5) Income tax withholdings Net tax payable (or refund due) for 2012 Notes (1) (2) (3) (4) (5)
$12,964 3,800
(16,764) $ 94,598 $ 19,948 (18,000) $ 1,948
$60,000 (33,000)
$140,000 27,000 (10,000) (–0–) 6,000 (100,000) (3,000) $ 60,000
$20,000 (100) (6,000) $5,000 (1,200)
(13,900) (8,000) (3,800) (18,000) (7,600) $ 8,700 $ 870 (3,000) ($2,130)
No bad debt deduction on uncollected rents can be taken because Alan and Ruth are cash basis taxpayers. Rent collected from prior year must be included in gross income because Alan and Ruth are cash basis taxpayers. The loss of up to $100,000 on the § 1244 stock is classified as ordinary loss. The additional $5,000 loss on § 1244 stock is short-term capital loss. Only $3,000 of the loss can be used to offset ordinary income. Alan and Ruth’s filing status is that of married filing jointly. Tax on $8,700 ($8,700 × 10%) = $870
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7-26
2013 Individual Income Taxes/Solutions Manual
Proposed solutions to the Research Problems are found at the Instructor Companion Site for the textbook (www.cengage.com/taxation/swft). Previously, these items were a part of the Instructor’s Guide, but now they are available online at this site as free-standing documents, as well as on the Instructor’s Resource CD.
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Deductions and Losses: Certain Business Expenses and Losses 60.
7-27
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7-28 60. continued
2013 Individual Income Taxes/Solutions Manual
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Deductions and Losses: Certain Business Expenses and Losses 60. continued
7-29
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7-30 60. continued
2013 Individual Income Taxes/Solutions Manual
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Deductions and Losses: Certain Business Expenses and Losses 60. continued
7-31
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7-32 60. continued
2013 Individual Income Taxes/Solutions Manual
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Deductions and Losses: Certain Business Expenses and Losses 60. continued
7-33
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7-34 60. continued
2013 Individual Income Taxes/Solutions Manual
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Question/ Problem 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28
Learning Objective LO 1 LO 1 LO 1 LO 1 LO 1 LO 1 LO 1 LO 2 LO 2 LO 3, 4 LO 3, 4 LO 4 LO 4 LO 4 LO 4 LO 4 LO 4 LO 4 LO 4 LO 4 LO 3, 4 LO 5 LO 5 LO 6 LO 6 LO 6 LO 7 LO 7
Topic Bad debts: accounts receivable Bad debts: basis Bad debts: worthlessness Bad debts: recovery Bad debts: business Bad debts: business Worthless securities versus theft loss Worthless securities versus bad debts Section 1244 stock Casualty loss versus business loss Casualty loss Casualty loss: timing Casualty loss: reimbursement Casualty loss: measurement rule for theft Casualty …show more content…
loss: insurance claim Casualty loss: cost of repairs method Casualty loss: rental property Casualty loss: miscellaneous itemized deductions Casualty loss: 10% of AGI floor Casualty loss: occurrence Casualty loss: occurrence Research expenditures Research expenditures Research expenditures Domestic production activities deduction (DPAD): tax benefit Domestic production activities deduction (DPAD): NOL effect Net operating loss: definition Net operating loss: unreimbursed employee business expense 7-1
Status: Present Edition New Unchanged Unchanged Modified Unchanged Unchanged Unchanged Unchanged Modified Modified Unchanged Unchanged Unchanged New Unchanged Unchanged Modified Unchanged New Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Modified New
Q/P in Prior Edition 2 3 4 5 6 7 8 9 10 11 12 13 15 16 17 18 20 21 22 23 24 25 26 27 28
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7-2
2013 Individual Income Taxes/Solutions Manual Status: Present Edition Unchanged Unchanged Unchanged Unchanged Modified Unchanged Modified Unchanged Modified Unchanged Modified Unchanged Modified Modified Unchanged Q/P in Prior Edition 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43
Question/ Problem 29 30 31 32 33 34 *35 *36 *37 *38 *39 *40 *41 42 43
Learning Objective LO 7 LO 7
Topic
44
45 46
*47 *48 *49 *50 *51 52 *53 *54 *55
Net operating loss: itemized deductions Net operating loss: effect of carryback on charitable contribution LO 7 Net operating loss: calculation and carryback LO 1 Bad debts: nonbusiness LO 1 Bad debts: nonbusiness LO 1 Bad debts: business LO 1, 2 Bad debt and § 1244 stock and capital loss limit LO 2, 8 Section 1244 stock LO 4 Casualty loss: personal and business LO 3, 4, 8 Casualty loss: disaster area loss LO 3, 4 Casualty loss: business versus personal use property LO 3, 4 Casualty loss: insurance recovery LO 5 Research expenditures LO 6 Domestic production activities deduction (DPAD) LO 6 Domestic production activities deduction (DPAD): qualified production activities income (QPAI) and AGI for individual LO 6 Domestic production activities deduction (DPAD): qualified production activities income (QPAI) and NOL LO 6 Domestic production activities deduction (DPAD): qualified production activities income (QPAI) LO 6 Domestic production activities deduction (DPAD): qualified production activities income (QPAI) and W-2 wage limit LO 7 Net operating loss: calculation LO 7 Net operating loss: calculation LO 7 Net operating loss: calculation, recomputed taxable income, and remaining NOL LO 7 Net operating loss: calculation for farming business LO 7 Net operating loss: carryover for farming business LO 7 Net operating loss: farming business LO 7 Net operating loss: carryover LO 7 Net operating loss: calculation and carryover LO 1, 2, 7 Net operating loss and § 1244 stock: calculation
Modified
44
Unchanged Unchanged
45 46
Updated Modified Updated Updated Updated Unchanged Updated Updated Modified
47 48 49 50 51 52 53 54 55
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Deductions and Losses: Certain Business Expenses and Losses Status: Present Edition Unchanged Unchanged Unchanged Unchanged Modified New
7-3 Q/P in Prior Edition 56 57 58 59 60
Question/ Problem *56 *57 *58 *59 *60 *61
Learning Objective LO 1, 3
Topic
AGI computed with bad debts and net capital loss LO 1, 4 AGI computed with bad debts and personal casualty gain LO 1, 4, 7 Net operating loss and personal casualty loss LO 1, 2, Net operating loss, § 1244 stock, and 3, 4, 7 personal casualty loss Cumulative Cumulative
*The solution to this problem is available on a transparency master. Status: Present Edition Unchanged Unchanged Unchanged New Unchanged Unchanged Unchanged Q/P in Prior Edition 1 2 3 5 6 7
Research Problem 1 2 3 4 5 6 7
Topic Bad debts Net operating loss Casualty or theft loss Casualty loss deduction Casualty loss deduction Internet activity Internet activity
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7-4
2013 Individual Income Taxes/Solutions Manual CHECK FIGURES
32. 33. 34. 35. 36. 37. 38. 39. 40. 41.a. 41.b. 42. 43. 44. 45. 46. 47.a. 47.b. 48.a. 48.b.
In the year of complete worthlessness. Include $7,000 in gross income. $5,000 bad debt deduction. Negative $17,000. Mary should sell half each year. $53,000 AGI, $33,940 deduction. $60,000 loss should be taken currently. AGI of $75,000; $37,400 itemized deduction. Net cash benefit of $7,800 of filing an insurance claim. 2012 $619,000; 2013 $703,000; 2014 $0. 2012 $0; 2013 $0; 2014 $132,198. $30,000. $49,500. $90,000. $5 ($6 – $1). $200,000. ($13,750). No NOL. ($46,400). NOL of $35,000.
49.a. 49.b. 49.c. 50.a. 50.b. 50.c. 50.d. 51.a. 51.b. 52.a. 52.b. 52.c. 53. 54.a. 54.b. 54.c. 55.a. 55.b. 56. 57. 58. 59. 60. 61.
$33,000. $0. $3,900. ($85,600). $75,000. $75,000. Back 5 years and forward 20 years. $0. $62,725. ($83,600). ($70,000). ($50,000). $4,450. ($24,500). No NOL. $16,900 NOL carryforward. NOL of $19,000. 2-year carryback. $48,000. $55,000. Taxable income ($17,000); NOL $0. $79,900. Refund due for 2011 $1,142. Refund due for 2012 $2,130.
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Deductions and Losses: Certain Business Expenses and Losses DISCUSSION QUESTIONS 1. 2. 3. 4.
7-5
An account receivable can give rise to a bad debt deduction if income arising from the creation of the account receivable was previously included in gross income. p. 7-3 Mike’s basis in the receivable would be the $7,000 ($10,000 × 70%) he paid for the receivable. Therefore, if he collects $6,000, he will have a bad debt of $1,000 ($7,000 – $6,000). p. 7-4 A loss is deductible only in the year of total worthlessness for a nonbusiness bad debt and is classified as a short-term capital loss. pp. 7-4 and 7-5 Jane must include the $5,000 in gross income of the current tax year, but only to the extent of the tax benefit in the previous year. Because Jane had capital gains of $2,000 in the previous year, the $50,000 bad debt could be used to the extent of $5,000 ($2,000 + $3,000) last year. Hence, Jane would have to include the $5,000 received in gross income in the current year. p. 7-4 The non-collection of an account would be considered a business bad debt. As such, it would be deducted as an ordinary loss in the year incurred. A business bad debt can be deducted based on either partial worthlessness or complete worthlessness. However, the amount of the deduction is limited to Bob’s basis in the account (what he paid for the account), not its face value. pp. 7-4 and 7-5 The business bad debt is treated as an ordinary loss and hence, the fact that the business has long-term capital gains has no relevance. pp. 7-4 and 7-5 Jack should be concerned with the following issues: • • Should this be treated as a worthless security? Should this be treated as a theft loss? • • Does the theft loss create an NOL? Can the NOL be carried back 3 years?
5.
6. 7.
pp. 7-6 and 7-20 8. Sean cannot take the loss as a business bad debt because a bond is a security. Sean cannot take the loss as a worthless security because losses are allowed only when the security is completely worthless. p. 7-6 The gain on the sale of § 1244 stock is treated as a capital gain. pp. 7-6 and 7-7 Some courts have held that termite damage over periods of up to 15 months after infestation constituted a sudden event and was, therefore, deductible as a casualty loss. However, the current position of the IRS is that termite damage is not deductible. p. 7-8 Casualty losses are not allowed for a decline in the value of the property. Losses are allowed only for actual damage. p. 7-8 Generally, a casualty loss is deducted in the year the loss occurs. However, no casualty loss is permitted if a reimbursement claim with a reasonable prospect of full recovery exists. If the taxpayer has a partial claim of recovery, only part of the loss can be claimed in the year
9. 10.
11. 12.
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7-6
2013 Individual Income Taxes/Solutions Manual of the casualty, and the remainder is deducted in the year the claim is settled. pp. 7-9 and 7-10
13.
Mary should include the recovery as gross income in her 2012 tax return, but only to the extent of the tax benefit in the prior year. Mary’s deduction in the prior year would have been $3,900 computed as follows: Amount of loss Less: $100 floor 10% × 40,000 Deduction $8,000 (100) (4,000) $3,900
Therefore, Mary must include $3,900 in gross income in 2012. pp. 7-9 to 7-12 14. 15. The amount of the loss is the adjusted basis of the property for the theft of property used in a transaction entered into for profit. pp. 7-11 and 7-14 A taxpayer is not permitted to deduct a casualty loss for damage to insured personal use property unless a timely insurance claim is filed with respect to the damage to the property. If the taxpayer does not file an insurance claim, the loss must be reduced by the proceeds that could have been received from the insurance company. pp. 7-11 and 7-12 The cost of repairs can be used as a method for measuring the amount of a casualty loss if the repairs are necessary to restore the property to its condition before the casualty, the amount spent for the repairs is not excessive, and the repairs do not extend beyond the damage suffered. In addition, the value of the property after the repairs must not, as a result of the repairs, exceed the value of the property immediately before the casualty. p. 7-12 The property has been completely destroyed. Hence, the amount of the loss is $650,000 (the adjusted basis). p. 7-11 If the painting is treated as personal use property, the amount of the loss is limited to $40,000 and is subject to the $100 and 10%-of-AGI floors. However, if the painting is treated as investment property, the loss is $50,000 and is treated as an other miscellaneous itemized deduction and not subject to the 2%-of-AGI floor. Hence, all of the $50,000 could be taken as a deduction. pp. 7-11 and 7-12 If personal casualty gains exceed personal casualty losses, the gains and losses are treated as gains and losses from the sale of capital assets. The holding period depends on the period the taxpayer held each asset. pp. 7-14 and 7-15 Kelly should be concerned with the following issues: • • • Is this a theft loss? What is the amount of the loss? In which year can the loss be taken?
16.
17. 18.
19.
20.
pp. 7-9 to 7-12 21. The tax issues for John are as follows: • Is the loss a theft loss or an investment loss?
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Deductions and Losses: Certain Business Expenses and Losses • •
7-7
Is the loss subject to either the personal loss limits ($100 floor and 10%-of-AGI floor) or the limits on itemized deductions (2%-of-AGI floor)? How is the amount of the loss determined?
pp. 7-9 to 7-12 22. These modification costs should be capitalized and thus increase the basis of the building. The depreciation on the portion of the building used for research is a research and experimental expenditure. pp. 7-16 and 7-17 Research and experimental expenditures are usually amortized rather than expensed when a company does not have sufficient income to offset the expenses. pp. 7-16 and 7-17 The tax issues for Silver, Inc. are as follows: • Is the extraction and processing of silver ore a manufacturing activity? • • Can the deduction be taken for prior years? What laws will apply for prior years?
23. 24.
pp.
7-18 to 7-20 25. DPAD is a deduction that is determined in a unique manner. Unlike most deductions that are generated by expenditures, DPAD is based on income. If certain production activities produce a profit, DPAD is a percentage of that profit. Consequently, the larger the profit, the larger the deduction. Of course, the profit increases the income tax, while the deduction reduces the income tax. pp. 7-18 to 7-20 The taxable income limitation on the DPAD is determined after the application of any NOL deduction. Thus, a company with an NOL carryforward for a tax year is ineligible for the DPAD in the current year if the NOL carryforward eliminates current taxable income. A taxpayer that has an NOL carryback may lose part or all of the DPAD benefit for the tax year to which the NOL is applied. pp. 7-18 and 7-19 An unreimbursed employee business expense which is an itemized deduction is a business expense and hence, can create or increase an NOL for an individual taxpayer. p. 7-23 Individual Retirement Account deductions and alimony paid deductions are deductions for AGI. However, they are treated as nonbusiness deductions in computing an individual’s NOL. p. 7-23 Itemized deductions for personal casualty and theft losses and losses incurred in a transaction entered into for profit can create an NOL. p. 7-21 The AGI will be reduced by the NOL carryback, but this will not change the limit for the charitable contribution deduction in the carryback year. pp. 7-21 and 7-23 The tax issues for Thomas are as follows: • Are the following items trade or business deductions and hence, deductible in computing an
NOL?
26.
27. 28.
29. 30. 31.
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
7-8 • • •
2013 Individual Income Taxes/Solutions Manual Alimony payments. Moving expenses. Contributions to a traditional IRA.
pp. 7-19 to 7-23 PROBLEMS 32. Hoffman and Smith, CPAs 5191 Natorp Boulevard Mason, OH 45040 January 29, 2012 Mr. John Johnson 100 Tyler Lane Erie, PA 16563 Dear Mr. Johnson: This letter is to inform you of the possibility of taking a bad debt deduction. Your loan to Sara is a nonbusiness bad debt; therefore, you are not allowed to take a bad debt deduction for partial worthlessness. You will be able to take a bad debt deduction in the year in which the debt becomes wholly worthless. Should you need more information or need to clarify anything, please contact me. Sincerely, John J. Jones, CPA Partner TAX FILE MEMORANDUM January 29, 2012 From: Subject: John J. Jones Bad Debt Deduction
John Johnson’s $30,000 loan to Sara is a nonbusiness bad debt. Therefore, a bad debt deduction is not allowed for partial worthlessness. John will be able to claim a bad debt deduction in the year when the debt becomes wholly worthless. pp. 7-3 to 7-5 33. Monty must include up to $10,000 in gross income, but only to the extent of a tax benefit in a prior year. Because the debt is a nonbusiness bad debt, the $11,000 would have been reported as a short-term capital loss. Last year, Monty had capital gains of $4,000 and taxable
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Deductions and Losses: Certain Business Expenses and Losses
7-9
income of $20,000. Therefore, $7,000 of the $11,000 loss produced a tax benefit. Hence, only $7,000 would be included in Monty’s gross income this year. pp. 7-3 and 7-4 34. The potential bad debt is limited to Sally’s basis in the debt. Because she paid $60,000 for the account and collected $55,000, she has a bad debt of $5,000 ($60,000 – $55,000). pp. 7-4 and 7-5 Salary § 1244 ordinary loss (limit of $100,000) Short-term capital gain on § 1244 stock Short-term capital loss (nonbusiness bad debt) Net short-term capital gain Net long-term capital loss (remaining § 1244 loss) Net capital loss (limit) Adjusted gross income pp. 7-6 and 7-7 36. Sell all of the stock in the current year: Current year’s AGI Salary Ordinary loss (§ 1244 limit) Long-term capital gain Long-term capital loss ($80,000 – $50,000) Long-term capital loss (limit) AGI Next year’s AGI Salary Long-term capital gain Long-term capital loss carryover ($30,000 – $11,000) Long-term capital loss (limit) AGI Total AGI Current year Next year Total Sell half of the stock this year and half next year: Current year’s AGI Salary Ordinary loss (§ 1244 stock) Long-term capital gain AGI Next year’s AGI Salary Ordinary loss (§ 1244 stock) Long-term capital gain AGI $ 80,000 (40,000) 8,000 $ 48,000 $ 90,000 (40,000) 10,000 $ 60,000 $ 80,000 (50,000) (3,000) $ 27,000 $ 90,000 (3,000) $ 87,000 $ 27,000 87,000 $114,000 $120,000 (100,000)
35.
$20,000 (19,000) 1,000 (5,000)
(3,000) $ 17,000
$8,000 (30,000)
$10,000 (19,000)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
7-10 Total AGI Current year Next year Total
2013 Individual Income Taxes/Solutions Manual
$ 48,000 60,000 $108,000
Mary’s combined AGI for the two years is lower if she sells half of her § 1244 stock this year and half next year. p. 7-6 37. AGI before adjustment Adjustment ($11,000 gain on silverware – $8,000 loss on cash stolen) AGI Bearer bonds loss Miscellaneous itemized deduction for computer [$5,000 – 2%($53,000)] Total deduction pp. 7-7 to 7-13 38. The loss is a business loss. Therefore, for the farm building and the farm equipment that were completely destroyed, the adjusted basis is used in calculating the amount of the casualty loss. For the barn that was damaged, the lower of the adjusted basis or the decline in value is used in calculating the amount of the casualty. Building ($90,000 – $70,000) Equipment ($40,000 – $25,000) Barn ($50,000 – $25,000) Total loss $20,000 15,000 25,000 $60,000 $50,000 3,000 $53,000 $30,000 3,940 $33,940
Because the President declared the area a disaster area, Olaf and Anna could claim the loss on last year’s return or on the current year’s tax return. If Olaf applies the loss to the prior year, the benefit of the loss will be at a tax rate of 28%. If the loss is applied to the current year, the benefit will be at a tax rate of 33% rather than 28% and thus, provide a tax savings of $19,800 ($60,000 × 33%) rather than $16,800 ($60,000 × 28%). Olaf should include the loss on the current year’s tax return, since the tax savings is $3,000 ($19,800 – $16,800) greater. pp. 7-7 to 7-13 39. Cost Depreciation Adjusted basis Loss on building: Loss ($900,000 – $200,000) Less: Insurance reimbursement Loss (gain) Total $800,000 (100,000) $700,000 $700,000 $600,000 Business Portion (40%) $320,000 (100,000) $220,000 $220,000* (240,000) ($ 20,000) Personal Portion (60%) $480,000 (–0–) $480,000 $420,000 (360,000) $ 60,000
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Deductions and Losses: Certain Business Expenses and Losses Business contents loss Less: Insurance recovery Loss Personal casualty gain—contents ($ 65,000 insurance proceeds – $50,000 adjusted basis) Personal casualty loss—building AGI before effects of accident Business gain—building Business loss—contents Personal casualty gain Personal casualty loss to extent of gain AGI Personal casualty loss—building ($60,000 – $15,000 – $100) Less: 10% of AGI floor (10% × $75,000) Itemized deduction $220,000 (175,000) $ 45,000 $ 15,000 ($ 60,000) $100,000 20,000 (45,000) 15,000 (15,000) $ 75,000 ($ 44,900) 7,500 ($ 37,400)
7-11
*Adjusted basis is less than the decline in FMV of $280,000 ($700,000 × 40%). pp. 7-7 to 7-15 40. Hoffman and Smith, CPAs 5191 Natorp Boulevard Mason, OH 45040 January 26, 2012 Mr. Sam Smith 450 Colonel’s Way Warrensburg, MO 64093 Dear Mr. Smith: This letter is to inform you of the tax and cash flow consequences of filing a claim versus not filing a claim with your insurance company for reimbursement for damages to your business use car. If an insurance claim is filed, you will have a taxable gain of $2,000 computed as follows: Insurance recovery Less: Lesser of adjusted basis of $10,000 or decline of FMV of $12,000 Gain This will produce a net cash flow of $11,300 computed as follows: Insurance reimbursement received Less: Tax on gain (35% × $2,000) Net cash flow $12,000 (700) $11,300 $12,000 (10,000) $ 2,000
If no insurance claim is filed, you will have a deductible loss of $10,000 which will reduce your tax liability by $3,500 (35% × $10,000).
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7-12
2013 Individual Income Taxes/Solutions Manual The net cash benefit resulting from filing an insurance reimbursement claim would be $7,800 ($11,300 – $3,500). Should you need more information or need to clarify anything, please contact me. Sincerely, John J. Jones, CPA Partner TAX FILE MEMORANDUM January 26, 2012 From: Subject: John J. Jones Tax consequences for Sam Smith if he does not file an insurance claim for reimbursement for damages to his business use car.
If an insurance claim is filed, Sam will have a taxable gain of $2,000 computed as follows: Insurance recovery Less: Lesser of adjusted basis of $10,000 or decline of FMV of $12,000 Gain This will produce a net cash flow of $11,300 computed as follows: Insurance reimbursement received Less: Tax on gain (35% × $2,000) Net cash flow $12,000 (700) $11,300 $12,000 (10,000) $ 2,000
If no insurance claim is filed, Sam will have a deductible loss of $10,000 which will reduce his tax liability by $3,500 (35% × $10,000). In my correspondence with Sam, I pointed out the net cash benefit from filing an insurance reimbursement claim would be $7,800 ($11,300 − $3,500). pp. 7-11 to 7-15 41. a. 2012 Salaries Materials Insurance Utilities Equipment depreciation Total expenses $500,000 90,000 8,000 6,000 15,000 $619,000
Cost of inspection of materials for quality control ($7,000), promotion expenses ($11,000), and cost of market survey ($8,000) are not included as research and experimental expenditures. 2013 Salaries Materials $600,000 70,000
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Deductions and Losses: Certain Business Expenses and Losses Insurance Utilities Equipment depreciation Total expenses 11,000 8,000 14,000 $703,000
7-13
Cost of inspection of materials for quality control ($6,000), advertising ($20,000), and promotion expenses ($18,000) are not included as research and experimental expenditures. 2014 No deduction based on data provided. b. The research and experimental expenditures are amortized over a 60-month period beginning with the month in which the taxpayer first realizes benefits from the experimental expenditures (i.e., July 2014 for Blue Corporation). The monthly amortization is $22,033 ($1,322,000 ÷ 60). 2012 No deduction for research and experimental expenditures. 2013 No deduction for research and experimental expenditures. 2014 Deduction for research and experimental expenditures: $22,033 × 6 months = $132,198 pp. 7-16 and 7-17 42. 43. 44. Sarah’s DPAD is $30,000 [9% × $350,000 (the smaller of $350,000 modified AGI or $400,000 QPAI)] [not to exceed $30,000 (50% × $60,000 of W-2 wages)]. pp. 7-18 to 7-20 Barbara’s DPAD in 2012 is $49,500 [9% × $550,000 (the smaller of $600,000 AGI and $550,000 QPAI)]. pp. 7-18 and 7-19 Red Corporation’s taxable income for the year is $1,200,000 ($2,000,000 – $800,000 NOL). This is not less than the QPAI ($1,000,000) and hence, the QPAD is $90,000 (9% × $1,000,000). This assumes the QPAD is not limited by W-2 wages. pp. 7-18 and 7-19 The QPAI for a skirt is $6 ($12 – $5 – $1). The QPAI for a blouse is a negative $1 ($10 – $6 – $5). Green must net the two items to arrive at the QPAI of $5 ($6 – $1). pp. 7-18 and 7-19 The DPAD is $200,000 (50% × $400,000 associated W-2 wages) which is less than $270,000 (9% × $3,000,000). Because the wage base limits the deduction, Rose may want to outsource less of its work. pp. 7-18 and 7-19 a. Business income Business expenses Net business income Interest income Alimony paid AGI Less: Standard deduction Personal exemption $70,000 (65,000) $ 5,000 3,000 (12,000) ($ 4,000) (5,950) (3,800)
45. 46.
47.
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7-14
2013 Individual Income Taxes/Solutions Manual Taxable income b. Taxable income Add: Personal exemption Excess of nonbusiness deductions over nonbusiness income [($5,950 + $12,000) – $3,000] No NOL ($13,750) ($13,750) 3,800 14,950 $ 5,000
pp. 7-20 to 7-23 48. a. Business receipts Less: Business expenses Net business loss Alimony received Interest income Adjusted gross income Less: Itemized deductions Personal and dependency exemptions (3 × $3,800) Taxable income Taxable income Add: Personal and dependency exemptions Excess of nonbusiness deductions ($24,000) over nonbusiness income ($3,000 + $22,000) NOL $144,000 (180,000) ($ 36,000) 22,000 3,000 ($ 11,000) (24,000) (11,400) ($ 46,400) ($46,400) 11,400 –0– ($35,000)
b.
In calculating the NOL, the alimony received of $22,000 is not treated as business income. pp. 7-20 to 7-23 49. a. Business receipts Less: Business expenses Net business loss Salary Ordinary nonbusiness income Nonbusiness short-term capital gain $20,000 Nonbusiness long-term capital loss (9,000) Net short-term capital gain Adjusted gross income Less: Itemized deductions Personal exemptions (2 × $3,800) Taxable income Add: Excess of nonbusiness deductions over nonbusiness income and net nonbusiness capital gains [$18,000 – ($8,000 + $11,000)] $ –0– Personal exemptions (2 × $3,800) 7,600 Net operating loss for 2012 pp. 7-20 to 7-23 b. Net business income Interest income 2012 net operating loss Adjusted gross income $60,000 2,000 (33,000) $29,000 $276,000 (320,000) ($ 44,000) 10,000 8,000 11,000 ($ 15,000) (18,000) (7,600) ($ 40,600)
7,600 ($ 33,000)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Deductions and Losses: Certain Business Expenses and Losses Less: Itemized deductions Charitable contribution is not affected by the NOL Medical expenses of $6,550, limited to the amount in excess of the new AGI ($6,550 – $2,175) Total itemized deductions Less: Personal exemptions (2 × $3,700) Recomputed taxable income for 2011 p. 7-24 c. Net business income Interest income Adjusted gross income Less: Itemized deductions Charitable contributions of $40,000, limited to 50% of new AGI* $31,000 Medical expenses of $6,550, limited to the amount in excess of 7.5% of new AGI* ($6,550 – $4,650) 1,900 Total itemized deductions Less: Personal and dependency exemptions (not allowed) Modified taxable income for 2011 Net operating loss for 2012 Less: Modified taxable income for 2011 Net operating loss to carry forward to 2013 $60,000 2,000 $62,000
7-15
$31,000 4,375
(35,375) (7,400) $ –0–
(32,900) (–0–) $29,100 $33,000 (29,100) $ 3,900
*Note: In this problem, the revised AGI is the same as the original AGI. If there had been a net capital loss deduction, it would have been eliminated as an adjustment and AGI would have increased. pp. 7-20 to 7-26 50. a. Business receipts from farming Less: Business expenses for farming Net business loss Interest income Salary Net capital gain Adjusted gross income Less: Itemized deductions Personal exemptions (2 × $3,800) Taxable income Taxable income Add: Personal exemptions Excess of nonbusiness deductions over nonbusiness income and nonbusiness capital gains: $400,000 (525,000) ($125,000) 8,000 50,000 4,000 ($ 63,000) (15,000) (7,600) ($ 85,600) ($ 85,600) $7,600
b.
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7-16
2013 Individual Income Taxes/Solutions Manual Itemized deductions Less: Interest income Capital gain Net operating loss $15,000 (8,000) (4,000)
3,000
10,600 ($ 75,000)
The farming loss is limited to $75,000 (the amount of the NOL). c. d. Rick and Sara’s NOL for 2012 is $75,000. Since the NOL relates to a farming loss, it can be carried back five years and forward 20 years.
pp. 7-20 to 7-26 51. a. Salary Capital loss 2012 net operating loss Adjusted gross income Less: Itemized deductions Charitable contributions are not affected by the NOL Medical expenses of $2,100, limited to the amount in excess of 7.5% of the new AGI ($2,100 – $0) Total itemized deductions Less: Personal exemptions (2 × $3,700) Recomputed taxable income for 2011 $25,000 (1,000) (75,000) ($51,000) $12,000 2,100
(14,100) (7,400) $ –0– $25,000 (–0–) $25,000
b.
Salary Capital loss (not allowed) Adjusted gross income Less: Itemized deductions Charitable contribution of $20,000, limited to 50% of new AGI $12,500 Medical expenses of $2,100, limited to the amount in excess of 7.5% of the new AGI ($2,100 – $1,875) 225 Total itemized deductions Less: Personal and dependency exemptions (not allowed) Modified taxable income for 2011 Net operating loss for 2012 Modified taxable income for 2011 Net operating loss to carry forward to 2013
(12,725) (–0–) $12,275 ($75,000) 12,275 ($62,725)
pp. 7-20 to 7-26 52. a. Farming income Less: Farming expenses Net farming loss Interest income Adjusted gross income Less: Itemized deductions ($20,000 + $12,000) Personal exemptions (2 × $3,800) Taxable income $300,000 (350,000) ($ 50,000) 6,000 ($ 44,000) (32,000) (7,600) ($ 83,600)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Deductions and Losses: Certain Business Expenses and Losses b. Taxable income Add: Personal exemptions Excess of nonbusiness deductions over nonbusiness income: Itemized deductions Less: Casualty loss Interest income Excess NOL c. d. ($ 83,600)
7-17
$7,600 $32,000 (20,000) $12,000 (6,000)
6,000
13,600 ($ 70,000)
The farming loss is $50,000 because it is less than the NOL of $70,000. The $50,000 farming loss can be carried back five years and forward 20 years. The remaining $20,000 ($70,000 – $50,000), which relates to the casualty loss, can be carried back three years and forward 20 years. pp. 7-20 to 7-26 Hoffman and Smith, CPAs 5191 Natorp Boulevard Mason, OH 45040
53.
February 6, 2012 Mr. and Ms. Robert Reid 201 Jerdone Avenue Conway, SC 29526 Dear Mr. and Ms. Reid: In response to your inquiry concerning the amount of net operating loss remaining if the 2012 loss of $30,000 is applied against the 2011 taxable income of $14,850, the amount of net operating loss remaining is $4,450, computed as follows: Salary Capital loss (not allowed) Adjusted gross income Less: Itemized deductions Charitable contribution of $24,000, limited to 50% of new AGI Medical expenses of $4,200, limited to the amount in excess of 7.5% of the new AGI ($4,200 – $3,750) Total itemized deductions Less: Personal exemptions (not allowed) Modified taxable income for 2011 Net operating loss for 2012 Modified taxable income for 2011 Net operating loss to carry forward to 2013 $50,000 (–0–) $50,000 $24,000 450
(24,450) (–0–) $25,550 ($30,000) 25,550 ($ 4,450)
Should you need more information or need to clarify anything, please contact me. Sincerely yours,
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7-18
2013 Individual Income Taxes/Solutions Manual John J. Jones, CPA Partner TAX FILE MEMORANDUM February 1, 2012 From: Subject: John J. Jones Robert and Susan Reid’s net operating loss carryforward
If Robert and Susan Reid apply their 2012 NOL of $30,000 against their 2011 taxable income of $14,850, the remaining NOL to carry forward is $4,450, computed as follows: Salary Capital loss (not allowed) Adjusted gross income Less: Itemized deductions Charitable contribution of $24,000, limited to 50% of new AGI Medical expenses of $4,200, limited to the amount in excess of 7.5% of the new AGI ($4,200 – $3,750) Total itemized deductions Less: Personal exemptions (not allowed) Modified taxable income for 2011 Net operating loss for 2012 Modified taxable income for 2011 Net operating loss to carry forward to 2013 pp. 7-20 to 7-26 54. a. Salary Interest income 2011 NOL AGI Less: Standard deduction Personal exemptions (2 × $3,800) Taxable income Taxable income Add: Personal exemptions Excess of nonbusiness deductions over nonbusiness income ($11,900 – $5,000) 2011 NOL carryforward No NOL Salary Interest income AGI Less: Standard deduction Personal exemptions (not allowed) Modified taxable income $50,000 5,000 (60,000) ($ 5,000) (19,500) ($24,500) ($24,500) 7,600 6,900 60,000 $50,000 $50,000 5,000 $55,000 (11,900) (–0–) $43,100 $50,000 (–0–) $50,000 $24,000 450 (24,450) (–0–) $25,550 ($30,000) 25,550 ($ 4,450)
$11,900 7,600
b.
c.
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Deductions and Losses: Certain Business Expenses and Losses NOL Modified taxable income NOL carryforward pp. 7-20 to 7-26 55. a. Salary Interest income (taxable government bonds) Dividends Ordinary loss on § 1244 stock ($20,000 – $65,000) Business bad debt Short-term capital gains and losses Short-term capital gain ($4,000 – $800) Short-term capital loss (nonbusiness bad debt) Net short-term capital loss Long-term capital gains and losses Gain ($40,000 – $18,000) Loss Net long-term capital gain Net capital gain Adjusted gross income Less: Itemized deductions Personal exemption (1 × $3,800) Taxable income Add: Personal exemption Excess of nonbusiness deductions over nonbusiness income plus net nonbusiness capital gains Total itemized deductions $25,000 Less: Interest (2,000) Dividends (500) Net nonbusiness capital gain (20,200) Net operating loss for 2012 $30,000 2,000 500 (45,000) (4,000) $3,200 (5,000) ($1,800) $22,000 (–0–) $22,000 ($60,000) 43,100 ($16,900)
7-19
$ 3,800
20,200 $ 3,700 (25,000) (3,800) ($25,100)
2,300
6,100 ($19,000)
b.
Because this is a 2012 NOL, it is carried back 2 years to 2010.
pp. 7-4 to 7-7 and 7-19 to 7-22 56. Salary Interest income Business bad debt Nonbusiness bad debt (short-term capital loss) Short-term capital loss Total short-term capital loss Long-term capital gain Net short-term capital loss Capital loss limit Adjusted gross income pp. 7-4 and 7-5 $50,000 3,000 (2,000)
($6,000) (3,000) ($9,000) 4,000 ($5,000)
(3,000) $48,000
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7-20 57.
2013 Individual Income Taxes/Solutions Manual Salary Interest income Business bad debt Nonbusiness bad debt Short-term capital loss Total short-term capital loss Short-term capital gain* Net short-term capital gain Long-term capital gain Long-term capital loss* Net long-term capital gain Adjusted gross income $50,000 3,000 (2,000)
($6,000) (3,000) ($9,000) 10,000 $4,000 (1,000)
1,000 3,000 $55,000
*Personal casualty gains exceed personal casualty losses ($10,000 – $1,000 = $9,000); therefore, all personal casualty items are treated as capital gains and losses. pp. 7-3, 7-4, and 7-13 to 7-15 58. Salary Interest income Business bad debt Nonbusiness bad debt Short-term capital loss Total short-term capital loss Long-term capital gain Net short-term capital loss Capital loss limited to $3,000 Personal casualty gains* Personal casualty losses* Adjusted gross income Less: Itemized deductions Interest expense Casualty losses in excess of casualty gains ($61,000 – $10,000) Less: 10% AGI (10% × $48,000) Casualty loss Total itemized deductions Less: Personal exemption (1 × $3,800) Taxable income (loss) $50,000 3,000 (2,000)
($ 6,000) ( 3,000) ($ 9,000) 4,000 ($ 5,000)
(3,000) 10,000 (10,000) $48,000
$15,000 $51,000 (4,800)
46,200
(61,200) (3,800) ($17,000)
*Personal casualty losses exceed gains; therefore, all items are treated as ordinary items. Assume that a personal casualty loss means that the $100 floor already has been deducted. pp. 7-13 to 7-15 Taxable income Add: Personal exemption Excess of nonbusiness capital losses over nonbusiness capital gains to the extent included in taxable income Excess of nonbusiness deductions over nonbusiness income: Total itemized deductions Less: Casualty loss $3,800 3,000 $61,200 (46,200) ($17,000)
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Deductions and Losses: Certain Business Expenses and Losses Nonbusiness deductions Less: Interest income No loss p. 7-23 59. Salary State of Minnesota bond interest (Note 1) Ordinary § 1244 loss ($120,000 – $30,000) Long-term capital gain—land ($60,000 – $42,000) Long-term capital loss—worthless securities Net long-term capital gain Short-term capital loss—nonbusiness bad debt Net long-term capital gain Adjusted gross income Less: Itemized deductions Home mortgage interest Casualty loss—personal ($610,000 – $540,000) Less: $100 floor Less: 10% AGI floor Total itemized deductions Less: Personal exemptions (2 × $3,800) Taxable income (loss) Add: Personal exemptions Excess of nonbusiness deductions over the sum of nonbusiness income plus net nonbusiness capital gains ($14,000 – $3,000) (Note 2) Net operating loss Notes (1) (2) $15,000 (1,000)
7-21
14,000
($
20,800 –0–)
$80,000 –0– (90,000) $18,000 (5,000) $13,000 (10,000)
3,000 ($ 7,000)
$14,000 $70,000 (100) (–0–)
69,900
$ 7,600
(83,900) (7,600) ($98,500)
11,000
18,600 ($79,900)
The $40,000 of interest income from the State of Minnesota bonds is tax-exempt income. For this purpose, the personal casualty loss is treated as a business loss (i.e., is not classified as a nonbusiness deduction).
pp. 7-3 to 7-7, 7-11 to 7-13, 7-20, 7-21, and 7-23 CUMULATIVE PROBLEMS 60. Part 1— Tax Computation Salary and bonus ($100,000 + $1,000) Typing service business net receipts ($20,000 – $24,580) Interest income (Note 1) Life insurance proceeds (Note 2) Gift (Note 3) Bingo prize Alimony Nonbusiness bad debt (Note 4) $101,000 (4,580) 700 –0– –0– 100 10,000 (2,100)
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7-22
2013 Individual Income Taxes/Solutions Manual Adjusted gross income Less: Itemized deductions Home mortgage interest Charitable contributions Sales taxes Casualty loss: Lesser of adjusted basis of $14,000 or FMV of $15,000 $14,000 Less: Insurance proceeds (1,500) $12,500 Less: $100 floor (100) Less: 10% AGI floor (10,512) Total itemized deductions Less: Personal exemption Taxable income Tax on taxable income (from Tax Table) Less: Federal income tax withheld and estimated tax payments ($18,000 + $1,000) Net tax payable (or refund due) for 2011 See the tax return solution beginning on page 7-26 of the Solutions Manual. Notes (1) (2) (3) (4) The $800 interest on the City of Boca Raton bonds is tax-exempt. Life insurance proceeds of $60,000 payable as the result of the death of Jane’s sister are excludible from gross income. The $5,000 gift from Jane’s aunt is excludible from gross income. The $2,100 loss on the loan to her friend, Joan Jensen, is deductible as a nonbusiness bad debt (i.e., short-term capital loss). The loan is a bona fide loan. $105,120 $9,500 2,500 964
1,888
(14,852) (3,700) $86,568 17,858 (19,000) ($ 1,142)
Part 2— Tax Planning Salary and bonus Gross receipts from business Less: Office rent Supplies Utilities and telephone Wages Payroll taxes Equipment rentals Net business income Interest income Alimony Adjusted gross income Less: Itemized deductions Personal exemption Taxable income $26,000 $7,000 4,840 5,148 5,500 550 3,300 $101,000
(26,338)
(338) 700 10,000 $111,362 (16,764) $ 94,598
$12,964 3,800
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Deductions and Losses: Certain Business Expenses and Losses
7-23
Tax on $94,598 [$17,443 + .28($94,598 – $85,650)] $19,948 Less: Federal income tax withheld (18,000) Net tax payable (or refund due) $ 1,948 Jane would need to make estimated tax payments of $1,948 for 2012 because the Federal income tax withholdings are expected to be less than the tax liability. Hoffman and Smith, CPAs 5191 Natorp Boulevard Mason, OH 45040 January 26, 2012 Ms. Jane Smith 2020 Oakcrest Road Boca Raton, FL 33431 Dear Ms. Smith: This letter is in response to your request concerning the minimum amount of estimated tax you will have to pay for 2012 so that you will not have to pay any additional tax upon filing your 2012 Federal income tax return. Based on the 2012 estimates you provided to us, we have determined that your estimated tax payments for the 2012 calendar year should total $1,948. This estimate is based on the following computation. Salary and bonus Gross receipts from business Less: Office rent Supplies Utilities and telephone Wages Payroll taxes Equipment rentals Net business income Interest income Alimony Adjusted gross income Less: Itemized deductions Personal exemption Taxable income Tax on $94,598 Less: Federal income tax withheld Net tax payable (or refund due) $26,000 $7,000 4,840 5,148 5,500 550 3,300 $101,000
(26,338)
(338) 700 10,000 $111,362 (16,764) $ 94,598 $ 19,948 (18,000) $ 1,948
$12,964 3,800
Should you need more information or need to clarify anything, please contact me. Sincerely yours, John J. Jones, CPA Partner
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7-24
2013 Individual Income Taxes/Solutions Manual TAX FILE MEMORANDUM January 10, 2012 From: Subject: John J. Jones Jane Smith’s 2012 estimated tax
Today I talked with Jane Smith concerning her 2012 estimated tax. She wanted to know the minimum amount of estimated tax she would have to pay for the calendar year 2012 so that she would not have to pay any additional tax upon filing her 2012 Federal income tax return. The following projections for 2012 were provided by Jane Smith: Items remaining unchanged from 2011: Salary—$50,000 Christmas bonus—$1,000 Itemized deductions—$12,964 Interest income—$700 Alimony—$10,000 Gross receipts from typing services—$26,000 Office rent will remain unchanged—$7,000 All other expenses for typing services will increase 10% from 2011: Supplies—$4,400 in 2011; $4,840 in 2012 Utilities and telephone—$4,680 in 2011; $5,148 in 2012 Wages—$5,000 in 2011; $5,500 in 2012 Payroll taxes—$500 in 2011; $550 in 2012 Equipment rentals—$3,000 in 2011; $3,300 in 2012 The following 2011 items will not recur in 2012: Life insurance proceeds—$60,000 Gift—$5,000 Bingo winnings—$100 Bad debt—$2,100 Stolen silverware Based on these estimates for 2012, Jane Smith should make 2012 estimated tax payments totaling $1,948. The determination was made as follows: Salary and bonus Gross receipts from business Less: Office rent Supplies Utilities and telephone Wages Payroll taxes Equipment rentals Net business income Interest income Alimony Adjusted gross income $26,000 $7,000 4,840 5,148 5,500 550 3,300 $101,000
(26,338)
(338) 700 10,000 $111,362
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Deductions and Losses: Certain Business Expenses and Losses Less:
7-25
Itemized deductions Personal exemption Taxable income Tax on $94,598 Less: Federal income tax withheld Net tax payable (or refund due) 61. Salary Rental income Less: Rental expenses Casualty loss on rental property Bad debt on uncollected rent (Note 1) Rent collected from prior year (Note 2) Ordinary loss on § 1244 stock (Note 3) Short-term capital loss—limit (Note 4) AGI Less: Itemized deductions Personal casualty loss Less: $100 floor Less: 10% AGI Loss on investment property (painting) Loss on computer Less: 2% AGI Other itemized deductions Less: Personal exemptions (2 × $3,800) Taxable income Tax on $8,700 (Note 5) Income tax withholdings Net tax payable (or refund due) for 2012 Notes (1) (2) (3) (4) (5)
$12,964 3,800
(16,764) $ 94,598 $ 19,948 (18,000) $ 1,948
$60,000 (33,000)
$140,000 27,000 (10,000) (–0–) 6,000 (100,000) (3,000) $ 60,000
$20,000 (100) (6,000) $5,000 (1,200)
(13,900) (8,000) (3,800) (18,000) (7,600) $ 8,700 $ 870 (3,000) ($2,130)
No bad debt deduction on uncollected rents can be taken because Alan and Ruth are cash basis taxpayers. Rent collected from prior year must be included in gross income because Alan and Ruth are cash basis taxpayers. The loss of up to $100,000 on the § 1244 stock is classified as ordinary loss. The additional $5,000 loss on § 1244 stock is short-term capital loss. Only $3,000 of the loss can be used to offset ordinary income. Alan and Ruth’s filing status is that of married filing jointly. Tax on $8,700 ($8,700 × 10%) = $870
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7-26
2013 Individual Income Taxes/Solutions Manual
Proposed solutions to the Research Problems are found at the Instructor Companion Site for the textbook (www.cengage.com/taxation/swft). Previously, these items were a part of the Instructor’s Guide, but now they are available online at this site as free-standing documents, as well as on the Instructor’s Resource CD.
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Deductions and Losses: Certain Business Expenses and Losses 60.
7-27
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7-28 60. continued
2013 Individual Income Taxes/Solutions Manual
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Deductions and Losses: Certain Business Expenses and Losses 60. continued
7-29
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7-30 60. continued
2013 Individual Income Taxes/Solutions Manual
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Deductions and Losses: Certain Business Expenses and Losses 60. continued
7-31
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7-32 60. continued
2013 Individual Income Taxes/Solutions Manual
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Deductions and Losses: Certain Business Expenses and Losses 60. continued
7-33
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7-34 60. continued
2013 Individual Income Taxes/Solutions Manual
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