SOLUTIONS MANUAL FOR South-Western Federal Taxation 2025 Comprehensive 48th Edition. James Young, Ma by StudyGuide

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 1: An Introduction to Taxation and Understanding the Federal Tax Law

Solution and Answer Guide

YOUNG, PERSELLIN, NELLEN, MALONEY, CUCCIA, LASSAR, CRIPE, SWFT COMPREHENSIVE VOLUME 2025, 9780357988817; CHAPTER 1: AN INTRODUCTION TO TAXATION AND UNDERSTANDING THE FEDERAL TAX LAW

TABLE OF CONTENTS Discussion Questions...........................................................................................................1 Research Problems ........................................................................................................... 10 Solution To Ethics & Equity Feature .................................................................................12 Solutions To Becker CPA Review Questions ....................................................................12

DISCUSSION QUESTIONS 1.

(LO 1) Various answers are possible, including using the Key Terms at the end of each chapter, referring to the Glossary (Appendix C), looking up the footnote resources to the Internal Revenue Code in Appendix D, using chapter features (e.g., Global Tax Issues, Ethics & Equity, Tax Planning, and Framework 1040), examining the tax forms used in the chapters, and completing additional end-of-chapter assignments. All of these resources will help students engage more deeply with the materials and help their understanding.

2. (LO 1, 4) a. John must now document rental receipts and separate his home expenses between personal and rental use, and he may be subject to the transient occupancy tax. b. Theresa has become self-employed. Now she will be subject to self-employment tax and may have to make quarterly installment payments of estimated income and self-employment tax. Theresa will be required to make payroll tax payments if she hires individuals to work in her business. c. Paul’s employer might have some moving expenses that it can deduct (in general, Paul cannot deduct moving expenses). Paul’s personal taxes will change because Florida does not impose an income tax but California does. 3. (LO 1, 4) The income tax consequences that result are Marvin’s principal concern. Any rent he receives is taxed as income, but operating expenses and depreciation will generate deductions that offset some or all of the income or even yield a loss. Marvin must also consider the effect of other taxes. Because the property is being converted from residential to commercial use, he can expect an increase in the ad valorem property taxes levied by the local (and perhaps even the state) taxing authorities. Besides the real estate taxes, personal property taxes could be imposed on the furnishings. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

4. (LO 2) To finance our participation in World War II, the scope of the income tax was expanded considerably—from a limited coverage of 6% to over 74% of the population. Hence, the description of the income tax as being a “mass tax” became appropriate. 5. (LO 2) For wage earners, the tax law requires employers to withhold a specified dollar amount from wages paid to the employee to cover income taxes and payroll taxes. Persons with nonwage income generally are required to make quarterly payments to the IRS for estimated taxes. Both procedures ensure that taxpayers will be financially able to meet their annual tax liabilities. That is, the amounts withheld are meant to prepay the employee’s income taxes and payroll taxes related to the wages earned. 6. (LO 3) The tax law of this state appears to violate the certainty and simplicity principles. 7. (LO 3) A tax is regressive if it represents a larger percentage of the income of a lowincome taxpayer relative to the income of a high-income taxpayer. Examples of regressive taxes include sales and excise taxes. A tax is progressive if it represents a larger percentage of the income of a high-income taxpayer relative to the income of a low-income taxpayer. The Federal income tax is an example of a progressive tax. 8. (LO 4) a. The parsonage probably was not listed on the property tax rolls because it was owned by a tax-exempt church. Apparently the taxing authorities are not aware that ownership has changed. b. Ethan should notify the authorities of his purchase. This will force him to pay back taxes but may eliminate future interest and penalties. 9. (LO 4) Although the Baker Motors bid is the lowest from a long-term financial standpoint, it is the best. The proposed use of the property by the state and the church probably will make it exempt from the school district’s ad valorem tax. This would hardly be the case with a car dealership. In fact, commercial properties (e.g., car dealerships) often are subject to higher tax rates. 10. (LO 4) a. In this case, the “tax holiday” probably concerns exemption from ad valorem taxes. “Generous” could involve an extended period of time (e.g., 10 years) and include both realty and personalty. b. The school district could be affected in two ways. First, due to the erosion of the tax base, less revenue would be forthcoming. Second, new workers would mean new families and more children to educate. 11. (LO 4) A possible explanation is that Sophia made capital improvements (e.g., added a swimming pool) to her residence and her parents became retirees (e.g., reached age 65). 12. (LO 4) Presuming that the dockage facilities are comparable in Massachusetts, the Agarwals may be trying to avoid ad valorem taxes on their boat. They should review the property tax laws of these two states to determine if the property tax on the boat is owed based on where the boat is moored or where the owner resides (or possibly both). In addition, some other factor, such as where the boat is registered or titled, might be important.

13. (LO 4) In general, Federal excise taxes apply to fewer items than in the past. Lawmakers have focused on and increased certain Federal excise taxes (e.g., those on tobacco products, gasoline, and air travel). 14. (LO 4) Jayla could have been overcharged, but it is likely that at least part of the excess is attributable to a hotel occupancy tax and a car rental tax. In major cities, these types of excise taxes have become a popular way of financing capital improvements such as sports arenas and stadiums. Consequently, the amount of the taxes could be significant. 15. (LO 4) (1) Income Taxes: Income taxes and employment taxes both fall into this category of tax because they are based on the taxpayer’s income. (2) Consumption Taxes: Sales tax and VAT fall into this category because they apply when the taxpayer purchases something. Most excise taxes fall into this category because they relate to the purchase of something such as gasoline, tobacco, alcohol, or airline tickets. State severance taxes also fall into this category given that the extraction is for consumption. But some, such as the 1 percent excise tax that some corporations will pay on stock buybacks, are not related to consumption. (3) Wealth (or Valuation) Taxes: Property taxes fall into this category because the tax base is the value of the property. Also, estate and gift taxes are computed on the value of the property given. 16. (LO 4) a. Jackson County must be in a state that imposes a lower (or no) sales tax. With certain major purchases (i.e., big-ticket items), any use tax imposed by the state of the Garcías’ residence could come into play. b. In some states, the sales tax rate varies depending on the county and/or city. Note: Generally, buyers are subject to the sales and use tax rate where they live. For example, if the Garcías buy goods in a different state with a zero or lower sales tax rate than in their state, they owe use tax to their home state for the difference. 17. (LO 4) Caleb probably purchased his computer out of state through a catalog or via the internet. In such cases, state collection of the sales (use) tax is not likely. Caleb needs to pay use tax on his own (which is equal to the sales tax). 18. (LO 4) If the tax is imposed on the right to pass property at death, it is classified as an estate tax. If it taxes the right to receive property from a decedent, it is termed an inheritance tax. a. Some states impose both an estate tax and an inheritance tax. Some states (e.g., Florida and Texas) levy neither tax. b. The Federal government imposes an estate tax.

19. (LO 4) Jake either has a severe misunderstanding as to the rules regarding transfer taxes or is lying to Jessica to delay any parting with his wealth. The marital deduction allows interspousal transfers (whether by gift or at death) free of any tax (either gift or estate). As a result, in the case of spousal transfers, there is no tax reason to prefer transfers at death over lifetime gifts. 20. (LO 4) a. The purpose of the unified transfer tax credit is to eliminate the tax on all but substantial gifts and estates. b. Yes. The credit for 2024 is $5,389,800; for 2023, it is $5,113,800. c. Yes. The credit is available to cover transfers by gift or by death (or both), but the amount can be used only once. 21. (LO 4) $684,000. 19 donees (5 married children + 5 spouses + 9 grandchildren) × $18,000 (annual exclusion for 2024) × 2 donors (Elijah and Anastasia) = $684,000. 22. (LO 4) The individual income tax is progressive in nature; the corporate income tax is assessed at a flat 21% rate. In addition, the corporate income tax does not make any distinction as to deductions—only business deductions are allowed. Nor does it require the computation of adjusted gross income (AGI) or provide for the standard deduction and the deduction for qualified business income. 23. (LO 4) a. For state income tax purposes, “piggyback” means making use of what was done for Federal income tax purposes. By “decoupling,” a state decides not to allow a particular Federal provision (e.g., exclusion, deduction, credit) for state income tax purposes. b. States often use IRS audit results to identify errors that might also exist on the taxpayer’s state tax return. c. Most states allow their residents some form of tax credit for income taxes paid to other states. 24. (LO 4) What happened here likely is not a coincidence. The IRS probably notified the state of California regarding Hernando’s omission of income, and California followed up with its own audit. 25. (LO 4) If Mike is drafted by a team in one of the listed states, he will escape state income tax on income earned within that state (e.g., training camp, home games). He will not, however, escape the income tax (state and local) imposed by jurisdictions where he plays away games. Called the “jock tax,” it is applied to out-of-state athletes and entertainers. 26. (LO 4, 5) a. This type of question has no relevance to the state income tax but is a reminder to individual taxpayers about the use tax and a simple way for individual taxpayers to pay any use tax due on internet and mail-order purchases. Without the line on the state income tax return, individual taxpayers would be required to file a separate use tax return.

b. As the preparer of the state income tax return, you should not leave questions unanswered unless there is a good reason for doing so. It appears that Hannah has no justifiable reason. 27. (LO 4) The checkoff boxes add complexity to the return and mislead taxpayers into presuming that they are not paying for the donation. 28. (LO 4) a. They uncover taxpayers who were previously unknown to the taxing authority. In addition, amnesty programs can bring taxpayers who are not in compliance with tax laws into compliance. b. Amnesty provisions can apply to other than income taxes (e.g., sales, franchise, severance). c. No general amnesty program has been offered for any Federal taxes. 29. (LO 4) a. FICA offers some measure of retirement security, and FUTA provides a modest source of income in the event of loss of employment. b. FICA is imposed on both employer and employee, while FUTA is imposed only on the employer. c. FICA is administered by the Federal government. FUTA, however, is handled by both the Federal and state government. d. This applies only to FUTA. The merit system rewards employers who have low employee turnover because this reduces the payout of unemployment benefits. 30. (LO 4) a. Unlike the Social Security portion of FICA, there is no dollar limit on the imposition of the Medicare tax. b. The 0.9% Medicare addition applies to taxpayers with wages or net selfemployment income in excess of $200,000 ($250,000 for married filing jointly). 31. (LO 4) Only children under age 18 who are employed in a parent’s unincorporated trade or business are excluded from FICA. Other family members, including spouses, must be covered. 32. (LO 4) a. Severance taxes are transaction taxes that are based on the notion that the state has an interest in its natural resources. The tax is imposed on the extraction of minerals. b. Franchise taxes are levied on the right to do business in the state. Typically, they are imposed on corporations and are based on their capitalization. c. Occupational fees are applicable to trades or businesses and are licenses to practice. Most are not significant revenue producers, and the amounts collected are utilized to defray the cost of regulating the profession.

d. Customs duties are taxes on the importation of certain foreign goods. They are imposed by the Federal government and are not found at the state and local level. e. Export duties are taxes imposed on the export of certain commodities (e.g., oil, coffee). They are common in less-developed nations and are not levied by the United States. 33. (LO 4) a. The United States is the only country in the OECD (Organization of Economic Cooperation and Development) that does not have a value added tax (VAT). Over 140 countries use a VAT. In spite of its extensive use by other countries, the adoption of a VAT by the United States appears doubtful. Instead, the United States places high reliance on the income tax as its major revenue source. b. A VAT taxes the increment in value as goods move through the production and manufacturing stages to the marketplace. Although the tax is paid by the producer, it is reflected in the selling price of the goods. Therefore, a VAT is a tax on consumption. c. Because it is an effective generator of revenue, the VAT has been criticized as leading to more government spending. 34. (LO 4) a. Both the national sales tax and the VAT are taxes on consumption. Both taxes impose more of a burden on low-income taxpayers who must spend a larger proportion of their incomes on essential purchases relative to higher-income taxpayers. As a result, the taxes are regressive in effect. b. The regressive effect might be partly remedied by granting some sort of credit, rebate, or exemption to low-income taxpayers. 35. (LO 4, 5) a. Serena may have record-keeping issues related to the cash transactions. The shortterm holiday workers should be on the payroll because they are employees, and Serena owes FICA and FUTA on their wages and must file Forms 940 and 941 with the IRS. Serena must also timely issue a W–2 wage form to each of her employees. b. High. First, Serena is self-employed. Second, she operates partially on a cash basis. Third, the opportunity to understate income and/or overstate expenses is high. Fourth, she has some workers who appear to be misclassified and for whom she may not have issued tax reporting forms. 36. (LO 5) a. A correspondence audit is probably involved. These audits involve a limited number of issues (i.e., taxpayer failed to report some dividend income) and most often are easily resolved. b. An audit that is conducted in an IRS office is called an office audit. c. The revenue agent’s report (RAR) accepts the taxpayer’s return as filed. d. When a special agent becomes involved, this usually means that fraud is suspected.

37. (LO 5) In many unresolved audit disagreements at the agent level, the taxpayer should consider an appeal to the Independent Office of Appeals. Although it is part of the IRS, it is authorized to resolve audit disputes. It has greater settlement authority than does the agent. In many cases, a compromise reached at the Independent Office of Appeals can avoid a costly and time-consuming judicial proceeding. 38. (LO 5) The purpose of a statute of limitations is to preclude parties from prosecuting stale claims. The passage of time makes the defense of such claims difficult because witnesses and other evidence may no longer be available. In the Federal tax area, statutes of limitations cover additional assessments by the IRS and the pursuit of refund claims by taxpayers. 39. (LO 5) a. The normal three-year statute of limitations will begin to run on the original due date of the return (usually the fifteenth day of the fourth month after year-end; April 15). When the return is filed early, the normal filing date controls. b. Now the statute of limitations starts to run on the filing date. If the due date controlled (see part a. above), the taxpayer could shorten the assessment period by filing late. c. If a return that is due is not filed, the statute of limitations does not start to run. It does not matter that the failure to file was due to an innocent error on the part of the taxpayer or adviser. d. Regardless of the fact that an innocent misunderstanding was involved, there is no statute of limitations when a return is not filed. 40. (LO 5) No. Interest is not paid if the refund is made within 45 days of when the return was filed. However, a return is not considered filed until its due date. As a result, the period from April 15 to May 28, 2024 does not satisfy the 45-day requirement. 41. (LO 5, 6) a. Normally, the three-year statute of limitations applies to additional assessments the IRS can make. However, if a substantial omission from gross income is made, the statute of limitations is increased to six years. A substantial omission is defined as omitting in excess of 25% of the gross income reported on the return. b. No, it would not. The proper procedure would be to advise Andy to disclose the omission to the IRS. Absent the client’s consent, do not make the disclosure yourself. c. If Andy refuses to make the disclosure and the omission has a material carryover effect to the current year, you should withdraw from the engagement. 42. (LO 5) $4,000, determined as follows: Failure to pay penalty [0.5% × $40,000 × 2 months] Plus: Failure to file penalty [5% × $40,000 × 2 months] Less failure to pay penalty for the same period Total penalties

$ 400 $4,000 (400)

3,600 $4,000

43. (LO 5) a. $100,000 (20% × $500,000). b. $375,000 (75% × $500,000). The answer presumes that civil (not criminal) fraud is involved. 44. (LO 5, 6) a. No. Because no return was filed, the statute of limitations never runs. But even if a return had been filed, the three-year period for the 2020 tax return would not expire until April 15, 2024, three years after the normal due date for filing. b. Although you can only recommend that the return be filed, you cannot force him to do so. However, you should not undertake the engagement for 2021 through 2023 if you cannot correctly reflect the tax liability due to the omission for 2020. c. As a CPA, you should consider Circular 230, the AICPA Rules of Professional Conduct, the AICPA SSTSs (assuming you are a member of the AICPA), and the rules of conduct for the state where you have your CPA license. 45. (LO 6) The SSTSs are available at: aicpa-cima.com/resources/download/revisedstatements-on-standards-for-tax-services-no-1-4-1-1-2024. a. While it is fine and usually beneficial to use tax preparation software, the preparer should be sure they understand how the software works and verify at least a sampling of items on returns and review all returns for completeness and accuracy. For a new tax calculation such as the renter’s credit, the preparer should be sure they understand how the credit is computed and then apply the provision to a variety of fact patterns (e.g., single taxpayers versus married taxpayers) without tax software and compare it to the software’s calculation of the credit to ensure that the software is computing the credit correctly. b. As noted in SSTS 1.4, members are responsible for their work product and should take “reasonable steps” to be sure any tools they use “are appropriate for the intended purpose.” A preparer should not rely on artificial intelligence (AI) to produce a tax answer for a client. If appropriate in terms of security and privacy, AI can be used, similar to conducting research, but as with any other research tool or resource, the preparer must still fully analyze and review the results for accuracy, completeness, and whether current tax law is appropriately applied. 46. (LO 5, 6) The practice of outsourcing the preparation of tax returns is ethical if three steps are taken. •

Maintain client confidentiality.

•

Verify the accuracy of the work done.

•

Notify the client, preferably in writing, of the outsourcing.

47. (LO 7) a. This is the ideal approach to handling a tax cut—for every dollar lost, a new dollar is gained.

b. All the sunset provision does is reinstate the law as it existed prior to the tax cut. Here, the possibility exists that Congress will rescind (or postpone) the sunset provision before it takes effect. c. Indexation is a procedure whereby the IRS makes annual adjustments to certain key tax components to take into account inflation, as required by law. Some of the more important components that are adjusted include tax brackets and the standard deduction amounts. 48. (LO 7) a. To encourage pension plans is to stimulate saving (economic consideration). Also, it provides security from the private sector for retirement to supplement public programs which tend to provide lesser benefits (social considerations). An opposing consideration is that only higher income individuals are able to fully fund their pension plans and thus gain the greater tax benefit from the favorable rules for retirement savings. b. To make education more widely available is to promote a socially desirable objective. A better educated workforce also serves to improve the country’s economic capabilities. As a result, education tax incentives can be justified on both social and economic grounds. A weakness in the current incentives is that they are only for college education, rather than also in preparation for other careers including health care, personal care, construction, and skilled trades (e.g., mechanics, electricians, and plumbers). c. The encouragement of home ownership can be justified on both social and economic grounds. For example, if a person owns a home and has no mortgage by the time they retire, their monthly living expenses will be lower. An opposing consideration to the tax breaks for home ownership is that the mortgage interest deduction applies to debt up to $750,000, thus providing a greater tax break to higher income individuals who can qualify for this large of a mortgage. Also, renters indirectly pay property taxes through their rent, but receive no tax deduction for that indirect payment. Finally, the home ownership tax breaks today apply once the home is acquired; there are no tax incentives to help an individual buy a home (such as a first-time homebuyer tax credit). 49. (LO 7, 8) a. Social considerations explain the credit. It is socially desirable to encourage parents to provide care for their children while they work. b. These deductions raise the issue of preferential tax treatment for homeowners— taxpayers who rent their personal residences do not receive comparable treatment. Even so, the encouragement of home ownership can be justified on economic and social grounds. c. The joint return procedure came about to equalize the position of married persons living in common law states with those residing in community property jurisdictions. Political and equity considerations caused this result. d. Activities deemed contrary to public policy should not result in tax savings.

e. The NOL carryforward provision is an equity consideration designed to mitigate the effect of the annual accounting period concept. f.

The installment method of reporting gain is consistent with the wherewithal to pay concept—the seller is taxed when the payments are made by the purchaser.

The exclusion from Federal income taxation of interest from state and local bonds can be justified largely on political considerations. Political goodwill is generated by allowing state and local jurisdictions to secure financing at a lower cost (i.e., interest rate) due to favorable Federal income tax treatment.

h. The treatment of prepaid income is justified under the wherewithal to pay concept. It also eases the task of the IRS as to administration of the tax law. 50. (LO 7) a. Mia’s realized gain from the condemnation is $320,000 [$400,000 (amount of award) − $80,000 (cost basis of the warehouse)]. However, her recognized gain is limited to $120,000—the amount received that was not reinvested. b. None of the gain is recognized because Mia reinvested the full amount of the condemnation award. c. In this case, all of Mia’s $320,000 realized gain is recognized. Mia reinvested only $80,000 of the $400,000 award, so the $320,000 difference between these two amounts means any realized gain will be recognized to the extent of this difference. d. The involuntary conversion provision can be justified under the wherewithal to pay concept and the notion that the taxpayer’s economic position has not changed. In part b., for example, Mia has retained none of the award and has reinvested in property similar to that taken by the city. 51. (LO 8) If the collection is worth more than $1,000, the mother has probably made a gift of the excess value to her son. There is a possibility that the transaction could result in the assessment of a gift tax. Sales or other transactions between related parties are subject to the arm’s length test. In this case, for example, would the mother have made this sale for $1,000 if the purchaser had been an unrelated third party?

RESEARCH PROBLEMS These research problems require that students utilize online resources to research and answer the questions. As a result, solutions may vary among students and courses. You should determine the skill and experience levels of the students before assigning these problems, coaching where necessary. Encourage students to use reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax professionals, academics, think tanks, and political outlets to research their answers. 1.

The sole proprietor is subject to Federal taxes on income, self-employment and payroll taxes (if the sole proprietor has employees), and the gasoline excise tax. State taxes include income and sales and use taxes. Local taxes include property tax, business license tax, and perhaps income tax.

2. An example of a carbon tax proposal of the 117th Congress is S. 1167, End Polluter Welfare Act. An example of a financial transaction tax proposal of the 118th Congress is H.R. 4119, Tax on Wall Street Speculation Act. Students might also find plans for these types of taxes that do not have legislative language. 3. An example of a sweetened beverage tax proposal is H.R. 2772 (117th Congress), the SWEET Act. Proposals also exist in a number of states and cities. Some cities, including Berkeley, California, Philadelphia, Pennsylvania, and Boulder, Colorado, have already enacted soda taxes. Considerations in analyzing these proposals include issues of regressivity (an equity and fairness issue), complexity of definitions, burden of enforcement, and neutrality in affecting decision making. Cook County, Illinois (Chicago) passed and then repealed a sweetened beverage tax due to a number of these issues. 4. Each of the Big Four firms has information on data analytics and how it can be used for tax purposes: •

pwc.com/us/en/services/consulting/cloud-digital/data-analytics.html

•

home.kpmg.com/xx/en/home/services/tax/global-indirect-tax/data-andanalytics.html

•

ey.com/en_us/big-data-analytics

•

www2.deloitte.com/us/en/pages/deloitte-analytics/solutions/deloitteanalytics.html

Students should also find how the IRS and state tax agencies are using big data to improve audit selection and enforcement. For example, see IRS information in the Internal Revenue Manual (IRM) 1.1.18, Research, Applied Analytics and Statistics Division at: •

irs.gov/irm/part1/irm_01-001-018

5. The Safeguards Rule was created as part of the Gramm-Leach-Bliley Act in 1999 (P.L. 106−102). The FTC summarizes this rule as follows: “The Safeguards Rule requires financial institutions under FTC jurisdiction to have measures in place to keep customer information secure. In addition to developing their own safeguards, companies covered by the Rule are responsible for taking steps to ensure that their affiliates and service providers safeguard customer information in their care.” This rule applies to all paid return preparers. •

ftc.gov/business-guidance/resources/ftc-safeguards-rule-what-your-businessneeds-know

IRS Publication 4557 includes several actions preparers should take to protect client data and meet the Safeguards Rule. In reviewing student answers, confirm that they understand the Safeguards Rule and why a preparer obtaining or renewing a PTIN is asked to confirm that they have a data security plan. The publication lists numerous actions, consider whether the three plan elements the student describes are among the most important.

In August 2022, the IRS Security Summit released a document with explanation and templates to help practitioners update or create a security plan. See IR−2022−147 (August 9. 2022) at irs.gov/newsroom/security-summit-releases-new-datasecurity-plan-to-help-tax-professionals-new-wisp-simplifies-complex-area. 6. Circular 230 § 10.35 on competence states that a practitioner may become competent for an engagement matter in a variety of ways, including by consulting with experts or studying the law. As a result, if someone at the firm gains a better understanding of virtual currency transactions, the record keeping needed to determine the tax consequences of over 2,500 trades and also consider other rules (e.g., the trader versus investor status of the client), they can accept this client. If the firm is not able to become competent, they may not accept this potential new client.

SOLUTION TO ETHICS & EQUITY FEATURE Making Good Use of Out-of-State Relatives (p. 1-14). Who is the true purchaser of the watch? If the aunt really made the purchase with her funds and then gave the watch to Marcus, no sales or use tax evasion has occurred. More likely, the purchase was made by Marcus indirectly through his aunt—the aunt being reimbursed by Marcus or using funds provided by him. If that is the case, Marcus owes a sales tax on the purchase. Presuming the matter comes to light—the jewelry store might be the weak link—Marcus could be subject to prosecution for tax evasion.

SOLUTIONS TO BECKER CPA REVIEW QUESTIONS 1.

Choice “a” is correct. Treasury Department Circular 230 is the IRS publication that addresses the practice before the IRS of practitioners with regard to the rules governing the authority to practice before the IRS, the duties and restrictions relating to practice before the IRS, the sanctions for violations of the regulations, and the rules applicable to disciplinary proceedings. Choice “b” is incorrect. Treasury Department Circular 230 does not provide guidance for practicing before the U.S. Tax Court but provides guidance for practicing before the IRS. Choice “c” is incorrect. Treasury Department Circular 230 does not address presenting before state boards of accountancy but provides guidance to practitioners on practicing before the IRS. Choice “d” is incorrect. The standards for the financial reporting of income taxes are found in Accounting Standards Codification (ASC) Section 740, not Treasury Department Circular 230.

2. Choice “b” is correct. All of the other choices are required conduct by a preparer of an income tax return. A preparer must make a reasonable attempt to obtain the necessary information from the taxpayer and make inquiries if the information appears to be incorrect or incomplete. The preparer is not responsible for verifying taxpayerprovided information. The taxpayer is actually responsible for providing the preparer with accurate information. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Choices “a,” “c,” and “d” are incorrect, as they are all required conduct by a preparer of an income tax return. A preparer must: •

Legally minimize the taxpayer’s tax liability and abide by the tax code.

•

Make a reasonable effort to obtain the necessary information from the taxpayer and make inquiries if the information appears to be incorrect or incomplete.

•

Recommend a tax return position only if the preparer has a good faith belief that the position has a realistic possibility of being sustained if challenged.

•

Notify the taxpayer if he or she becomes aware of a tax return error.

•

Inform the taxpayer on how to correct the situation of the taxpayer having failed to file a tax return.

•

Consider withdrawing from the engagement if the taxpayer does not correct the error or file the return the preparer advised him or her about.

•

Not inform the IRS without the taxpayer’s permission.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

Solution and Answer Guide

YOUNG, PERSELLIN, NELLEN, MALONEY, CUCCIA, LASSAR, CRIPE, SWFT COMPREHENSIVE VOLUME 2025, 9780357988817; CHAPTER 2: WORKING WITH THE TAX LAW

TABLE OF CONTENTS Discussion Questions...........................................................................................................1 Problems ........................................................................................................................... 10 Research Problems ........................................................................................................... 16 Solution To Ethics & Equity Feature ................................................................................ 19

DISCUSSION QUESTIONS 1.

(LO 1) Determining the intent of Congress is a large part of tax research. Reviewing the Committee Reports generated by the House Ways and Means Committee, the Senate Finance Committee, and the Joint Conference Committee (if convened) will assist in determining intent.

2. (LO 1) The many gray areas, the complexity of the tax laws, and the possibility of different interpretations of the tax law create the necessity of alternatives for structuring a business transaction. 3. (LO 1) Federal tax legislation generally originates in the House of Representatives, where it is first considered by the House Ways and Means Committee. 4. (LO 2, 5)

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040

October 16, 2024 Ms. Sonja Bishop Tile, Inc. 100 International Drive Tampa, FL 33620 Dear Ms. Bishop: This letter is in response to your request about information concerning a conflict between a U.S. treaty with Spain and a section of the Internal Revenue Code (IRC). The major reasons for treaties between the United States and certain foreign countries is to eliminate double taxation and to render mutual assistance in tax enforcement.

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Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

IRC § 7852(d) provides that if a U.S. treaty is in conflict with a provision in the IRC, neither will take general precedence. Rather, the more recent of the two will have precedence. In your case, the treaty with Spain takes precedence over the IRC section. A taxpayer must disclose on the tax return any positions where a treaty overrides a tax law. There is a $1,000 penalty per failure to disclose for individuals and a $10,000 penalty per failure to disclose for corporations. Should you need more information, feel free to contact me. Sincerely, Jeffrey Hanks, CPA Tax Partner 5. (LO 1, 2) Income tax Reg. § 1.

163–10

(a)

(2)

Type of Regulation Related Code Section Regulation Number Regulation Paragraph Regulation Subparagraph 6. (LO 1) There are a number of limitations on the percentage of depletion deduction, but there is a limited exception for independent producers and royalty owners. This deduction, however, is not available for a taxpayer that is a retailer or refiner. But § 613A(d)(4) indicates that a percentage depletion deduction “shall not apply to the taxpayer for a taxable year if the average daily refinery runs of the taxpayer and such persons for the taxable year exceed 75,000 barrels.” So, as long as the independent producer is refining 75,000 barrels or less in a taxable year, the percentage depletion deduction will be available. 7. (LO 1, 4) The items would probably be ranked as follows (from lowest to highest): (1)

Letter ruling (valid only to the taxpayer to whom issued).

(2)

Proposed Regulation (most courts ignore these).

(3)

Revenue Ruling.

(4)

Interpretive Regulation.

(5)

Legislative Regulation.

(6)

Internal Revenue Code.

8. (LO 1) a. This citation refers to a Temporary Regulation; 1 refers to the type of Regulation (i.e., income tax), 956 is the related Code section number, 2 is the Regulation section number, and T refers to temporary. b. Revenue Ruling number 15, appearing on page 975 of the 23rd weekly issue of the Internal Revenue Bulletin for 2012. c. Letter Ruling 51, issued in the 4th week of 2002.

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9. (LO 1, 5) TAX FILE MEMORANDUM DATE:

September 18, 2024

FROM:

George Ames

SUBJECT:

Telephone conversation with Sally Andrews on applicability of 2015 letter ruling

I informed Sally Andrews that only the taxpayer to whom the 2015 letter ruling was issued may rely on the pronouncement. I also stressed that a letter ruling has no precedential value under § 6110(k)(3). I pointed out that a letter ruling indicates the position of the IRS on the specific fact pattern presented as of the date of the letter ruling. As such, a letter ruling is not primary authority. However, under Reg. § 1.6662–4(d)(3), a letter ruling is substantial authority for purposes of the accuracy-related penalty in § 6662. 10. (LO 1) Sri should consider the following factors in determining whether he should request a letter ruling from the IRS with respect to the proposed stock redemption: •

For a fee, the IRS will issue a letter ruling at a taxpayer’s request and describe how the IRS will treat a proposed transaction. The letter ruling applies only to the requesting taxpayer. A Revenue Ruling is applicable to all taxpayers.

•

Sri must determine whether the possible tax amount is large enough to warrant the costs and time to apply for a letter ruling.

•

If Sri is likely to obtain an adverse letter ruling from the IRS National Office, he should forgo the ruling request.

•

The letter ruling would have substantial authority for purposes of the accuracyrelated penalty.

•

Sri needs to consult Rev.Proc. 2024–3 to be certain the IRS will issue a ruling about this tax issue. The IRS will not rule in certain areas that involve fact-oriented situations but will probably issue one here.

11. (LO 1) Letter rulings may be found in: •

IRS Letter Ruling Reports (CCH).

•

Bloomberg Tax Daily Tax Reports.

•

Tax Notes (Tax Analysts).

•

Letter rulings are also available in electronic (online) tax research services (e.g., Thomson Reuters Checkpoint).

12. (LO 1) TEAMs are issued by the Office of Chief Counsel to expedite legal guidance to field agents as disputes are developing. TEAMs differ from TAMs as follows: •

A mandatory presubmission conference involves the taxpayer.

•

In the event of a tentatively adverse conclusion to the taxpayer or to the field agent, a conference of right will be offered to the taxpayer and to the field agent.

•

No further conferences are offered once the conference of right is held.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

13. (LO 1) Sanjay must consider several factors in deciding whether to take the dispute to the judicial system: •

How expensive will it be?

•

How much time will be consumed?

•

Does he have the temperament to engage in the battle?

•

What is the probability of winning?

•

Once a decision is made to litigate the issue, the appropriate judicial forum must be selected.

•

Tax Court judges have more expertise in tax matters.

•

The tax deficiency need not be paid to litigate in the Tax Court. However, if Sanjay loses, interest must be paid on any unpaid deficiency.

•

If a trial by jury is preferred, the U.S. District Court is the appropriate forum.

•

The tax deficiency must be paid before litigating in the District Court or the Court of Federal Claims.

•

If an appeal to the Federal Circuit is important, Sanjay should select the Court of Federal Claims.

•

A survey of the decisions involving the issues in dispute is appropriate. If a particular court has taken an unfavorable position, that court should be avoided.

14. (LO 1) The main advantage of the U.S. Court of Federal Claims occurs when a taxpayer’s applicable Circuit Court previously rendered an adverse decision. Such a taxpayer may select the U.S. Court of Federal Claims because any appeal will be to the Federal Circuit. One disadvantage of the U.S. Court of Federal Claims is that the tentative deficiency must be paid before the Court will hear and decide the controversy. The U.S. Court of Federal Claims is a trial court that usually meets in Washington, D.C. It has jurisdiction for any claim against the United States that is based on the Constitution, any Act of Congress, or any Regulation of an executive department. 15. (LO 1, 5)

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040

July 9, 2024 Mr. Edmund Falls 200 Mesa Drive Tucson, AZ 85714 Dear Mr. Falls: You have three alternatives should you decide to pursue your $229,030 deficiency in the court system. One alternative is the U.S. Tax Court, the most popular forum. Overall, Tax Court judges have more expertise in tax matters. The main advantage is that the U.S. Tax Court is the only trial court where the tax need not be paid prior to

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

litigating the controversy. However, interest will be due on an unpaid deficiency. The interest rate varies from one quarter to the next as announced by the IRS. One disadvantage of the U.S. Tax Court is the delay that might result before a case is decided. The length of delay depends on the Court calendar, which includes a schedule of locations where cases will be tried. Another disadvantage is being unable to have the case heard before a jury. The major advantage of another alternative, the U.S. District Court, is the availability of a trial by jury. One disadvantage of a U.S. District Court is that the tentative tax deficiency must be paid before the Court will hear and decide the controversy. The Court of Federal Claims, the third alternative, is a trial court that usually meets in Washington, D.C. It has jurisdiction for any claim against the United States that is based on the Constitution, any Act of Congress, or any regulation of an executive department. The main advantage of the U.S. Court of Federal Claims occurs when a taxpayer’s applicable Circuit Court previously rendered an adverse decision. Such a taxpayer may select the Court of Federal Claims because any appeal will be to the Federal Circuit instead. One disadvantage of the Court of Federal Claims is that the tentative deficiency must be paid before the Court will hear and decide the controversy. I hope this information is helpful, and, should you need more help, please contact me. Sincerely, Abby Reynolds, CPA Tax Partner 16. (LO 1) The U.S. Tax Court hears only tax cases and is the most popular forum for tax cases (generally viewed as an advantage). Overall, Tax Court judges have more tax expertise; many had careers in the Treasury Department or the IRS before being appointed to the Tax Court. A taxpayer does not have to pay the tax deficiency assessed by the IRS before trial, but a taxpayer may deposit a cash bond to stop the running of interest (also viewed as an advantage). Appeals from a Tax Court are to the appropriate U.S. Court of Appeals. A disadvantage is that the taxpayer may not obtain a jury trial in the U.S. Tax Court. 17. (LO 1) See Exhibit 2.4, Exhibit 2.5, and Concept Summary 2.1. a. There is no appeal by either the taxpayer or the IRS from a decision of the Small Cases Division of the U.S. Tax Court. b. The first appeal would be to the Sixth Circuit Court of Appeals. Further appeal would be to the U.S. Supreme Court. c. Same as part b. above. d. The appeal would be to the Federal Circuit Court of Appeals and then to the U.S. Supreme Court. 18. (LO 1) The term petitioner is a synonym for plaintiff, which refers to the party requesting action in a court.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

19. (LO 1) Both the Code and the Supreme Court indicate that the Federal appellate courts are bound by findings of facts unless they are clearly erroneous. As a result, the role of appellate courts is limited to a review of the record of trial compiled by the trial courts. Therefore, the appellate process usually involves a determination of whether the trial court applied the proper law in arriving at its decision. Rarely will an appellate court disturb a lower court’s fact-finding determination. 20. (LO 1) See Concept Summary 2.1. a. Number of regular judges

U.S. Tax Court 19

U.S. District Court Varies; one judge hears a case

U.S. Court of Federal Claims 16

b. Jury trial

Yes

c. Prepayment of deficiency required before trial

Yes

21. (LO 1) See Exhibit 2.5. a. Tenth. b. Eighth. c. Ninth. d. Fifth. e. Seventh. 22. (LO 1) See Exhibit 2.4. a. The Tax Court must follow its own cases, the pertinent U.S. Circuit Court of Appeals, and the Supreme Court. b. The Court of Federal Claims must follow its own decisions, the Federal Circuit Court of Appeals, and the Supreme Court. c. The District Court must follow its own decisions, the pertinent U.S. Circuit Court of Appeals, and the Supreme Court. 23. (LO 1) The appropriate Circuit Court of Appeals for an appeal depends on where the litigation originated. For example, an appeal from Texas would go to the Fifth Circuit Court of Appeals, and an appeal from Colorado would go to the Tenth Circuit Court of Appeals. See Exhibit 2.5. 24. (LO 1, 2, 4) a. If the taxpayer chooses a U.S. District Court as the trial court for litigation, the U.S. District Court of Wyoming will be the forum to hear the case. Unless the prior decision has been reversed on appeal, one would expect the same court to follow its earlier holding. b. If the taxpayer chooses the U.S. Court of Federal Claims as the trial court for litigation, the decision that was rendered previously by this Court should have a direct bearing on the outcome. If the taxpayer selects a different trial court (i.e., the appropriate U.S. District Court or the U.S. Tax Court), the decision that

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

was rendered by the U.S. Court of Federal Claims will be persuasive but not controlling. It is, of course, assumed that the result that was reached by the U.S. Court of Federal Claims was not reversed on appeal. c. The decision of a U.S. Circuit Court of Appeals will carry more weight than one that was rendered by a trial court. Because the taxpayer lives in California, however, any appeal from a U.S. District Court or the U.S. Tax Court will go to the Ninth Circuit Court of Appeals (see Exhibit 2.4). Although the Ninth Circuit Court of Appeals might be influenced by what the Second Circuit Court of Appeals has decided, it is not compelled to follow such holding. See Exhibit 2.5. d. Because the U.S. Supreme Court is the highest appellate court, one can place complete reliance upon its decisions. Nevertheless, one should investigate any decision to see whether the Code has been modified with respect to the result that was reached. The rare possibility also exists that the Court may have changed its position in a later decision. See Exhibit 2.4. e. When the IRS acquiesces to a decision of the U.S. Tax Court, it agrees with the result that was reached. As long as such acquiescence remains in effect, taxpayers can be assured that this represents the position of the IRS on the issue that was involved. Keep in mind, however, that the IRS can change its mind and can, at any time, withdraw the acquiescence and substitute a nonacquiescence. f.

The issuance of a nonacquiescence usually reflects that the IRS does not agree with the result reached by the U.S. Tax Court. Consequently, taxpayers are placed on notice that the IRS will continue to challenge the issue that was involved.

25. (LO 2) The number 66 is the volume number for the U.S. Tax Court, 39 refers to the page number of the 562nd volume of the Federal Second Series, and nonacq. means that the IRS disagreed with the decision. The Tax Court (T.C.) cite is to the trial court. 26. (LO 1) There is no automatic right of appeal to the U.S. Supreme Court. Appeal is by Writ of Certiorari. If the Court agrees to hear the dispute, it will grant the Writ (Cert. granted). Most often, the highest court will deny jurisdiction (Cert. denied). 27. (LO 2) See Concept Summary 2.2. a. Ninth Circuit Court of Appeals. b. U.S. Tax Court. c. U.S. Supreme Court. d. Board of Tax Appeals (old name of U.S. Tax Court). e. Tax Court (memorandum decision). f.

Court of Claims.

Not a court decision.

h. District Court in New York. i.

Not a court decision.

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28. (LO 2) See Concept Summary 2.2. a. This citation is to a regular decision of the U.S. Tax Court that was issued in 1950. The decision can be found in Volume 14, page 74, of the Tax Court of the United States Report, published by the U.S. Government Printing Office. b. This citation is for a decision of the U.S. Fifth Circuit Court of Appeals that was rendered in 1979. The decision can be found in Volume 592, page 1251, of the Federal Reporter, Second Series (F.2d), published by West Publishing Company. c. This citation is for a decision of the U.S. Sixth Circuit Court of Appeals that was rendered in 1995. The decision can be found in Volume 1 for 1995, paragraph 50,104 of U.S. Tax Cases, published by Commerce Clearing House. d. This citation is for a decision of the U.S. Sixth Circuit Court of Appeals that was rendered in 1995. The decision can be found in Volume 75, page 110, of the Second Series of American Federal Tax Reports, published by RIA (Thomson Reuters). e. This citation is for a decision of the U.S. District Court of Texas that was rendered in 1963. The decision can be found in Volume 223, page 663, of the Federal Supplement Series, published by West Publishing Company. f.

This citation is to a decision of the U.S. First Circuit Court of Appeals that was rendered in 2007. The decision can be found in Volume 491, page 53, of the Federal Reporter, Third Series (F.3d), published by West Publishing Company.

This citation is to a decision of the U.S. District Court of the Virgin Islands that was rendered in 2011. The decision can be found in Volume 775, page 765, of the Federal Supplement, Second Series (F.Supp.2d), published by West Publishing Company.

29. (LO 2) See Concept Summary 2.2. a. None. b. USTC. c. USTC. d. USTC. e. TCM. 30. (LO 2) Decisions of the U.S. Court of Federal Claims (formerly named the Claims Court) are published in the USTCs (CCH); the AFTRs (RIA); and the West Publishing Co. reporter called the Federal Claims Reporter, Second Series (F.2d) (before October 1982) and the Claims Court Reporter (beginning October 1982 through October 30, 1992). The name of the U.S. Court of Federal Claims was changed from the Claims Court effective October 30, 1992. Currently, this court’s decisions are published in the Federal Claims Reporter. See Concept Summary 2.2. 31. (LO 1, 2) a. Yes. Exhibit 2.3. b. No. Not published there. Concept Summary 2.2. c. No. Published by private publishers and the IRS. Exhibit 2.3.

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d. Yes. Exhibit 2.3. e. Yes. Exhibit 2.3. f.

No. Concept Summary 2.2.

Yes. Exhibit 2.3.

h. No. Concept Summary 2.2. 32. (LO 3) After understanding the relevant facts and the accounting rules related to qualified stock options: •

Yvonne can begin with the index volumes of the available tax services: RIA, CCH, or BNA Portfolios.

•

A key word search on an online service should be helpful—Thomson Reuters Checkpoint, CCH IntelliConnect, LexisNexis, or Westlaw (or WestlawNext).

•

Yvonne should browse through IRS publications (available on the IRS website).

•

Yvonne could explore various tax periodicals (see text page 2-18) to locate appropriate articles written about qualified stock options.

•

Additional information might be available on the internet (but with caution regarding sources).

33. (LO 4) The current Code can be found in various places. Several of the major tax services publish paperback editions of the Code (and Regulations). These editions are usually revised twice each year. Further, the text of the Code may be found in the major tax services and as Title 26 of the U.S. Code. The Code also may be found on the Web. 34. (LO 2, 3, 4) One could start by doing a key word search on an online tax research service (e.g., Thomson Reuters Checkpoint). Checkpoint’s Federal Tax Updates might highlight recent developments in the area. Scanning through the table of contents for various tax publications (e.g., Tax Notes, The Tax Adviser, the Journal of Taxation; see text page 2-18) would also be useful. Court decisions, revenue rulings and procedures, and other relevant authority may be reviewed for reliability using a citator within the commercial tax service. A citator provides the history of a case, including the authority relied on (e.g., other judicial decisions) in reaching the result. Reviewing the references listed in the citator discloses whether the decision was appealed and, if so, with what result (e.g., affirmed, reversed, or remanded). It also reveals other cases with the same or similar issues and how they were decided. As a result, a citator reflects on the validity of a case and may lead to other relevant authority. If one intends to rely on a judicial decision to any significant degree, “running” the case through a citator is imperative. 35. (LO 6) The primary purpose of effective tax planning is to maximize the taxpayer’s after-tax wealth. This process can entail an avoidance, a reduction, or a postponement of the tax until the future. This process does not mean that the course of action selected must produce the lowest possible tax under the circumstances. Legitimate business goals also must be considered.

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There is nothing illegal or immoral about tax avoidance. But it is important to understand the difference between tax avoidance and tax evasion. A citizen has every legal right to arrange his or her affairs to keep the attendant taxes as low as possible. One is required to pay no more taxes than the law demands. 36. (LO 7) Task-based simulations on the CPA exam are case studies that allow candidates to demonstrate their knowledge and skills by generating responses to questions rather than simply selecting an answer. They typically require candidates to use spreadsheets and/or to research authoritative literature provided in the CPA exam (e.g., Internal Revenue Code, Treasury Department Regulations, IRS publications, and Federal tax forms). In addition, the task-based simulations provide increased background material and data that require candidates to determine what information is or is not relevant to the questions.

PROBLEMS 37. (LO 1) b. Subchapter C; see discussion on p. 2-5. 38. (LO 1, 2) a. Individual tax rates. b. Corporate tax rates. c. Definition of gross income. d. Definition of adjusted gross income. e. Trade or business deductions. f.

Production of income expenses.

Nondeductibility of personal expenses.

39. (LO 1, 2) a. In 2024, the Chair is Jason Smith. He represents the 8th District from the state of Missouri. b. In 2024, there are 43 members (25 Republican; 18 Democratic). c. The Committee on Ways and Means is the oldest committee of the United States Congress, and is the chief tax-writing committee in the House of Representatives. The Committee derives a large share of its jurisdiction from Article I, Section VII of the U.S. Constitution which declares, “All Bills for raising Revenue shall originate in the House of Representatives.” First established as a select committee on July 24, 1789, it was discharged less than two months later. The committee was reappointed from the first session of the Fourth Congress in 1795 and was formally listed as a standing committee in the House Rules on January 7, 1802. Until 1865, the jurisdiction of the committee (referred to as the Committee of Ways and Means before 1880) included the critically important areas of revenue, appropriations, and banking. Since 1865, the committee has continued to exercise jurisdiction over revenue and related issues such as tariffs, reciprocal trade agreements, and the

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

bonded debt of the United States. Revenue-related aspects of the Social Security system, Medicare, and social services programs also come within the scope of the Committee on Ways and Means. d. Currently, there are six subcommittees: Health, Oversight, Social Security, Tax Policy, Trade, and Work and Welfare. 40. (LO 1) b. Internal Revenue Bulletin; see Exhibit 2.3. 41. (LO 1) d. Temporary Regulations; see Exhibit 2.3. 42. (LO 1, 4) (1)

Code Section.

(2)

Legislative Regulation.

(3)

Recent Temporary Regulation.

(4)

Interpretive Regulation.

(5)

Revenue Ruling.

(6)

Proposed Regulation.

(7)

Letter Ruling.

43. (LO 1, 2) a. Provides various prescribed interest rates for Federal income tax purposes for the month of January 2021. The ruling includes short-term, mid-term, and long-term applicable Federal rates (AFR) for January 2021. b. Identifies the proper MACRS class (tax depreciation) for the depreciation of tangible assets that are used in converting corn to fuel grade ethanol. c. Discusses the tax treatment of allowances and reimbursements paid to a member of the U.S. House of Representatives. These include allowances for hiring clerks; obtaining office supplies and equipment, telephones, and computers and related services; renting a home district office, communicating with constituents, and traveling (among others). d. Discusses the tax treatment of ATM fees incurred by taxpayers when they obtain a cash advance from an ATM. 44. (LO 1, 2) a. Retroactive application of 50% “bonus” depreciation in 2014. b. Limitation of depreciation for autos placed in service in 2019. c. Casualty loss caused by deterioration of concrete foundations. d. Revisions to certain real property depreciation tables.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

45. (LO 1, 2) In Announcement 2020-1 (2020–5 I.R.B. 401), the IRS indicated that it had revoked the tax-exempt status of 44 different organizations. As of January 27, 2020, these organizations no longer qualify as tax-exempt organizations [under § 501(c)(3) and § 170(c)(2)]. 46. (LO 1, 2) In PLR 201450001, the IRS ruled on the appropriate cost recovery period for outdoor digital LED advertising displays following an election under the involuntary conversion rules to treat the displays as real property. 47. (LO 1, 2) a. Rev.Rul. 2019–22 (2019–14 I.R.B. 931). b. The phaseout of the electric vehicle credit for General Motors. c. If a new qualified plug-in electric drive motor vehicle sold by General Motors, LLC, is purchased for use or lease on or after April 1, 2019, the allowable credit is as follows: (1) For vehicles purchased for use or lease on or after April 1, 2019, and on or before September 30, 2019, the credit is 50% of the otherwise allowable amount determined under § 30D(b). (2) For vehicles purchased for use or lease on or after October 1, 2019, and on or before March 31, 2020, the credit is 25% of the otherwise allowable amount determined under § 30D(b). (3) For vehicles purchased for use or lease on or after April 1, 2020, no credit is allowable. 48. (LO 1) a. T. b. C (before October 1982) and A. c. D, C, A, and U. d. D, C, A, and U. e. U. f.

C and U.

h. D, T, and C. i.

A and U.

k. T. l.

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49. (LO 1) The differences between a Regular decision, a Memorandum decision, and a Summary Opinion of the U.S. Tax Court are summarized as follows: •

In terms of substance, Memorandum decisions deal with situations that require only the application of previously established principles of law. The dispute between the taxpayer and the IRS is typically over how the law applies to the particular facts. Regular decisions involve novel issues that have not been resolved by the Court. In actual practice, however, this distinction is not always observed.

•

Memorandum decisions officially were published until 1999 in mimeograph form only, but Regular decisions are published by the U.S. Government in a series that is designated as the Tax Court of the United States Reports. Memorandum decisions are now published on the Tax Court website. Both Regular and Memorandum decisions are published by various commercial tax services (e.g., CCH and Thomson Reuters).

•

A Summary Opinion is a Small Cases Division case involving amounts of $50,000 or less. They are not precedents for any other court decisions and are not reviewable by any higher court. Proceedings are timelier and less expensive than a Memorandum or Regular decision. Small cases decisions are published as Summary Opinion, found commercially and on the U.S. Tax Court website.

50. (LO 1, 2) Taxpayers who claim an itemized deduction for the interest they pay on adjustable-rate mortgages and receive a refund from their mortgage company in a following year must include the refund as income. Taxpayers who claimed the standard deduction rather than an actual interest deduction are not required to include the refund in income (Announcement 92–172). 51. (LO 1, 2) Loan origination fees (“points”) paid by the buyer with regard to VA and FHA loans may be treated as deductible points in the year of the sale (Rev.Proc. 92–12 and Rev.Proc. 94–27). 52. (LO 2) The IRS maintains a website on digital assets (including virtual currency): irs.gov/businesses/small-businesses-self-employed/digital-assets In addition, Notice 2014–21 (2014–21 I.R.B. 938) explains how existing tax principles apply to transactions involving virtual currency. In Notice 2014–21, the IRS concludes that virtual currency is property and that sales or exchanges of virtual currency result in capital gains or losses. Code § 1031 provides information on the tax consequences of like-kind exchanges. Currently, § 1031 only applies to real property (e.g., land and buildings). As a result, an exchange of cryptocurrencies (e.g., Bitcoin for Ethereum) will result in a capital gain or loss; § 1031 is not available. Notice 2014–21 also discusses the tax implications of mining a cryptocurrency (see Q-8, Q-9, and Q-10). When a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income. The question then becomes whether the mining of cryptocurrency is a “hobby” or a “trade or business.” The IRS references a news release from April 2007 (FS-2007-18) to help make this determination.

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If a taxpayer’s “mining” of virtual currency constitutes a trade or business and the “mining” activity is not undertaken by the taxpayer as an employee, the net earnings from self-employment (generally, gross income derived from carrying on a trade or business less allowable deductions) resulting from those activities constitute self-employment income and are subject to the self-employment tax. Consequently, the fair market value of virtual currency received for services performed as an independent contractor, measured in U.S. dollars as of the date of receipt, constitutes self-employment income and is subject to the self-employment tax. Beginning in 2025, cryptocurrency exchanges will be required to report a summary of any customer’s cryptocurrency transactions to the IRS. The IRS will be requiring this information to be reported on a Form 1099–DA (“DA” for “digital assets”). The form is expected to be similar to the form currently used by brokers to report transactions involving stocks, bonds, or other investment securities (Form 1099–B). In addition, the Treasury Department has released proposed regulations to guide cryptocurrency exchanges with this reporting. The blockchain is a public ledger that records all crypto transactions. While the identities of the parties involved are typically anonymous, the transactions themselves are visible. The IRS has partnered with companies that specialize in blockchain analysis to track cryptocurrency transactions on the blockchain. These companies use advanced software to analyze and trace transactions, allowing the IRS to identify patterns and track down individuals who may be engaging in tax evasion. 53. (LO 2) A letter ruling is a written determination issued by the IRS Office of Chief Counsel in response to a taxpayer’s written request, prior to the filing of a tax return (or other report required by law). Rev.Proc. 2024–1 (2024–1 I.R.B. 1) provides significant detail regarding this process (the revenue procedure is more than 115 pages long). The IRS will not provide rulings on certain issues [see, for example, Rev.Proc. 2024–3 (2024–1 I.R.B. 143)], and any ruling applies only to that taxpayer. In addition, any ruling can be revoked by the IRS. Rev.Proc. 2024–1 (which is updated annually) provides a schedule of user fees, a sample format for a letter ruling request, and a checklist for the request. Generally, the user fee is not refundable and the user fee can range from $30,000 to $38,000. Of course, the practitioner’s fee also must be factored into this decision. These costs mean that only those tax issues with significant tax costs are considered for a private letter ruling request. 54. (LO 2) The cost of the football tickets for Alejandra and Zach is considered to be an entertainment expense and is not deductible (see § 274). But the cost of the lunch is not considered entertainment because it was purchased separately. As a result, it is deductible as a meal expense (see Reg. § 1.274–12 and Notice 2018–76). The meal expense is subject to the 50% limitation (see § 274 and Reg. § 1.274–11). 55. (LO 2, 4) a. P. b. P. c. P. d. S. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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e. P. f.

P. Valid for three years.

h. P. i.

k. P. 56. (LO 1, 2) See Concept Summary 2.2. a. CCH. b. RIA. c. U.S. d. CCH. e. U.S. f.

RIA.

h. W. i.

k. U.S. l.

U.S.

57. (LO 1, 2) a. U.S. Supreme Court. b. 1955. c. This “landmark case” is where the Supreme Court defined the term income. Two cases with different facts but the same issue were consolidated by the Supreme Court in this opinion. The common question is whether money received as exemplary damages for fraud or as the punitive two-thirds portion of a trebledamage antitrust recovery must be reported by a taxpayer as gross income. The Supreme Court held that income is realized whenever there are “instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have compete dominion.” So here, both taxpayers had income. And because Congress had not provided an exclusion for these income items, both also were included in gross income.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

58. (LO 1, 2) a. The court addressed whether an interest the taxpayer held in various jet aircraft constituted a trade or business under § 162 (with a net loss allowed in determining the taxpayer’s taxable income) or a hobby under § 183 (with deductions limited to any income generated by the activity). The taxpayer asked the Tax Court to shift the burden of proof to the IRS (from the taxpayer) and asked the Court to excuse the substantial underpayment penalty due to reliance on professional advisers. b. The Tax Court held that the activity did not rise to the level of profit motive to permit deductions (i.e., it was a hobby under § 183). The burden of proof was not shifted to the IRS (so it was the taxpayer’s duty to provide evidence of profit motive), and the substantial underpayment penalty that was assessed as reliance on professionals was not supported by evidence. 59. (LO 1, 2) a. Speer v. Commissioner. b. U.S. Tax Court. c. 2015. d. The court addressed whether unused vacation and sick pay paid to the taxpayer upon retirement was includible as gross income. The taxpayer argued that some of the vacation and sick pay was accrued while the taxpayer was on temporary disability, and so some of the pay should be excluded from income. The Tax Court held that since the leave payments were not paid as workers’ compensation (i.e., for personal injuries or sickness), the payments were not excludible from income. 60. (LO 6) a. E. b. E. c. A. d. A. e. A.

RESEARCH PROBLEMS 1.

a. Higgens v. Comm., 312 U.S. 212 (1941). b. Talen v. U.S., 355 F.Supp.2d 22 (D.Ct. D.C., D.D.C., 2004). c. Rev.Rul. 2008–18, 2008–13 I.R.B. 674. d. Pahl v. Comm., 150 F.3d 1124 (CA–9, 1998). e. Veterinary Surgical Consultants PC, 117 T.C. 141 (2001). f.

Yeagle Drywall Co., T.C. Memo. 2001–284.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

2. IRC § 7463(b) states that a decision entered into by any small case decision “shall not be reviewed in any other court and shall not be treated as precedent for any other case.” In the reviewed opinion Larry Mitchell 131 T.C. 215 (2008), the court held that an exspouse’s share of military retirement payments is subject to tax. This same issue had been litigated previously by the taxpayer in Mitchell, T.C. Summ. 2004–160. In the past, the Tax Court has used collateral estoppel in small tax case decisions to stop (estop) a party from litigating the same issue in a regular Tax Court case. As a result, this reviewed decision seems to contradict their stance. Judge Holmes stated that this Tax Court decision means “that they are without effect on future litigation at all.” 3. For the Oprah car giveaway, the 234 audience recipients who received keys to a car were taxed on the value of the car, which was in the $30,000 range. Because they were merely present in the audience, the fair market value was included in gross income under § 61. As for the World Furniture Mall promotion, the discount or rebate could be tax-free because a rebate of all or a portion of the purchase price of property generally does not result in gross income. The customer would have a zero basis in the furniture. Rev.Rul. 76–96 and Rev.Rul. 88–95. See “Furniture for Nothing and It’s all Tax-Free,” Journal of Taxation, December 2006, pp. 382 and 383. 4. There does not appear to be a clear-cut answer to this question. Code § 104 allows exclusion from gross income for damages paid on account of physical injuries and physical sickness. However, the IRS requires observable bodily harm for an exclusion to be available (Ltr.Rul. 200041022). So is false imprisonment physical? In CCA 200809001, the IRS allowed an exclusion for a settlement with an institution for sexual abuse. However, the Tax Court in Daniel and Brenda Stadnyk, T.C. Memo. 2008–289 would not allow an exclusion for $49,000 received for about one day in a jail. Brenda Stadnyk was dissatisfied with an automobile purchase, so she placed a stop payment order on the check she tendered to the dealership. Bank One listed the reason for not paying the dealership as a “NSF check.” The dealership then filed a criminal complaint against her for passing a worthless check. She spent about one day in a holding area in a county jail. In “Why False Imprisonment Recoveries Should Not Be Taxable,” Tax Notes, June 8, 2009, pp. 1217–1220, Robert Wood provides a lengthy discussion of this problem.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

5. (1) A Google search will likely produce a variety of links, including one to Cornell University Law School’s Legal Information Institute (law.cornell.edu/uscode/text/26/61). This section defines gross income broadly. In addition to the 14 items specifically listed as income, § 61 directs the reader to other IRC sections and indicates that the list of income items is not all-inclusive. In general, the IRC takes a broad view of income; everything is income unless an IRC section specifies that the amount is not income. (2) To find the case, go to the U.S. Tax Court website and on the “Orders & Opinions” drop down menu, click on Opinions Search. Enter the name Mark Spitz in the “Case Name Keyword” field and click on the Search button. a. The tax years are 2001 and 2002, as indicated in the first sentence of the case, not 2006, the year in the citation, which is the year the case was decided. b. As noted above, 2006. c. The court decided in favor of the IRS. d. At the end of the decision, the penalty in § 6662 is discussed. This section imposes a 20% accuracy-related penalty on any portion of a tax liability underpayment (the situation in which Mr. Spitz found himself) attributable to a substantial understatement of income tax. Mr. Spitz was found not liable for the penalty because the court indicated that he was unsophisticated in tax law and had relied on a competent adviser to prepare his return. 6. a.

From the “Orders & Opinions” drop down menu, click on Opinions Search. On the “Opinions Search” tab, review the “Opinion Type” choices.

b./c.

From the “Orders & Opinions” drop down menu, click on Opinions Search. On the “Opinions Search” tab, select the appropriate opinion type, and enter a common last name in the “Case Name Keyword” bar.

From the “Rules & Guidance” drop down menu, click on Tax Court Rules.

The student e-mail should summarize the items above. Look for proper grammar and e-mail etiquette in addition to the correct answer.

7. Student responses will vary. 8. Student responses will vary. Tax Notes Federal published an article in May 2023 titled “The Rise of Generative AI in Tax Research” (papers.ssrn.com/sol3/papers.cfm?abstract_id=4476510). It provides a detailed discussion of generative AI tools, their potential benefits, identifies concerns, and discusses how these tools can be improved. Here are a variety of websites that students might find during their internet research: ey.com/en_gl/tax/how-generative-ai-might-help-tax-functions-tackle-challenges kpmg.com/xx/en/home/insights/2023/09/the-use-of-generative-ai.html pwc.com/us/en/tech-effect/ai-analytics/generative-ai-insights-for-tax-leaders.html

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 2: Working with the Tax Law

deloitte.com/us/en/pages/tax/articles/pairing-tax-with-artificial-intelligence.html bluej.com/blog/the-rise-of-generative-ai-in-tax-research qz.com/pwc-tax-advice-ai-chatgpt-consultation-bots-payment-1850937429 wsj.com/articles/pricewaterhousecoopers-to-pour-1-billion-into-generative-aicac2cedd

SOLUTION TO ETHICS & EQUITY FEATURE Reporting Tax Fraud (p. 2-7). A survey given in 2014 by the IRS Oversight Board indicated that 86% of Americans believe that it is unacceptable to cheat on their taxes. On the other hand, that same survey indicated that 11% of taxpayers said that some cheating on their taxes was acceptable. In October 2022, the IRS released its latest assessment of the tax gap (IR-2022-192). The IRS estimates that the gross average tax gap for the years 2014, 2015, and 2016 is about $496 billion per year. Voluntary payments or IRS administrative/enforcement efforts were $68 billion, resulting in a net tax gap of approximately $428 billion. These figures translate to around 85% of taxes being paid voluntarily and on time. See also irs.gov/pub/irspdf/p1415.pdf and irs.gov/pub/irs-pdf/p5365.pdf. In May 2021, the Department of the Treasury estimated the 2019 gross tax gap to be around $630 billion, with more than $3.6 trillion of taxes owed but only about $3 trillion paid voluntarily. Enforcement activities and late penalties brought in $76 billion of additional revenues. The Treasury Department estimated the voluntary compliance rate (after enforcement activities) to be about 84.8% (roughly the same as in the 2022 IRS study). The Treasury report is at home.treasury.gov/system/files/136/The-American-Families-Plan-TaxCompliance-Agenda.pdf. The Treasury Department attributes the tax gap to areas where there is limited information reporting (rental income and proprietorship income), sophisticated (and complex) pass-through entity structures, and offshore income. See also the Committee for a Responsible Federal Government blog on the tax gap (crfb.org/blogs/primerunderstanding-tax-gap). The Inflation Reduction Act of 2022 provided $80 billion in additional funding for the IRS over the next 10 years. Over half of this funding was appropriated for enforcement efforts to decrease the tax gap. According to the IRS, these funds will be used to examine large corporate and global high-net-worth taxpayers, pass-through entities, and multinational taxpayers who take aggressive tax positions. As part of the legislation to increase the debt ceiling in 2023, Congress and the White House agreed to reduce overall IRS funding by about $20 billion; it is unknown how this will affect future IRS enforcement efforts.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

Solution and Answer Guide

YOUNG, PERSELLIN, NELLEN, MALONEY, CUCCIA, LASSAR, CRIPE, SWFT COMPREHENSIVE VOLUME 2025, 9780357988817; CHAPTER 3: TAX FORMULA AND TAX DETERMINATION

TABLE OF CONTENTS Discussion Questions...........................................................................................................1 Computational Exercises ................................................................................................... 5 Problems ............................................................................................................................. 8 Tax Return Problems ........................................................................................................ 16 Research Problems ........................................................................................................... 20 Check Figures.................................................................................................................... 23 Solutions To Ethics & Equity Features ............................................................................ 24 Solutions To Becker CPA Review Questions ................................................................... 24

DISCUSSION QUESTIONS 1.

(LO 1, 5, 8) a. Gambling losses are deductible only to the extent of gambling gains. b. Barring an exception for dependents, no deduction is allowed for payment of some other person’s expenses. c. A Federal income tax refund is not income because it is an adjustment of a prior expenditure that was not deductible. d. Fines and penalties are not deductible. It does not matter whether they stem from personal or business activities. e. Political contributions are not deductible. It does not matter that the contribution resulted in a benefit to Addison. f.

Borrowing money does not result in income.

Gains and losses from the sale of personal use assets cannot offset each other. The gains are taxable, and the losses are not deductible.

h. No deduction can be claimed for income tax purposes for the funeral expenses. i.

Premiums on personal life insurance policies are not deductible even when paid on behalf of a dependent.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

2. (LO 1) The items included in gross income are parts b., c., f., g., h., and i. Explanations follow. a. The taxpayer still owns the stock. Because there is no realization event, there is no gross income. b. The police officer has earned income, and it is included in gross income. c. If the jewelry was sold at a gain, it is included in the mother’s gross income (this assumes that the son sold it for his mother). If sold at a loss, it is an unallowable loss on a personal use asset. d. Child support payments received are not included in gross income. e. The refunded deposit is a nontaxable return of capital. f.

Interest income on corporate bonds is included in gross income.

The baseball player has earned income, and it is included in gross income.

h. Tips are earned income and included in gross income. i.

Gain on the sale of property, even if the property is personal use property, is included in gross income [the gain would be the selling price of the tickets less their cost (basis)]. If a personal use asset is sold at a loss, the loss is not included in gross income.

A gift is an exclusion item, so it is not included in gross income. The grandmother may owe gift tax.

3. (LO 1) The treatment of all of the items in the problem are noted in the table below (with the Code section also noted). Exclusions b. Damages for personal injury (§ 104). d. Repayment of a loan does not involve income. Note that any interest received is income. e. Life insurance proceeds (§ 101).

f. Interest on municipal bonds (§ 103).

Inclusions (i.e., not excluded from income) a. Alimony received (§ 71). c. Prizes are taxable (§ 74). g. Jury duty fees are income and not excluded (§ 61). Note that if the taxpayer must repay the income to his employer, a deduction for AGI should be allowed (§ 62). h. Income from any source derived (even if illegal) is taxable unless excluded (§ 61). i. A whistleblower award is taxable, and no exclusion applies (§ 61). j. Found money is included in income (§ 61 and Reg. § 1.61–14).

4. (LO 1, 8) The sale of the stock investment will result in a capital loss. The capital loss will offset any capital gain, and any excess (up to $3,000) can be applied against ordinary income to arrive at AGI. The contribution to the traditional IRA is a deduction for AGI. Thus, both the capital loss and the IRA contribution reduce AGI. By reducing AGI, the Polks will increase their allowable medical and casualty deductions. [The medical deduction is the excess over 7.5% of AGI; the casualty loss is the excess over 10% of AGI.]

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

5. (LO 2) a. If the taxpayer is 65 or over, an additional standard deduction is available. This might favor the standard deduction choice. b. If the taxpayer is blind, an additional standard deduction is available. This might favor the standard deduction choice. c. If the taxpayer is still making house payments, the interest expense deduction on the home mortgage and real property taxes may make itemizing more attractive. d. Because the amount of the standard deduction varies depending on filing status, this factor is highly relevant to the taxpayer’s decision. e. If married persons file separate returns, the returns must be consistent. Thus, if one spouse itemizes, the other spouse also must itemize. f.

Because a large casualty loss seems probable, this increases the advantage to be gained by itemizing.

The number of dependents has no effect on whether a taxpayer itemizes or chooses the standard deduction option.

6. (LO 2, 3, 5) a. The filing requirements for persons being claimed as dependents by others are more complex than those applicable to regular taxpayers. The requirements depend on whether the dependent has only earned income, only unearned income, or both earned and unearned income and on the amount of gross income. b. In 2024, the basic standard deduction is the greater of $1,300 or earned income plus $450. The total basic standard deduction allowed, however, cannot exceed $14,600 (the 2024 standard deduction for single taxpayers). c. The 2024 additional standard deduction of $1,950 is allowed since David is 78 (age 65 or over). 7. (LO 4) The son is not a qualifying child due to the age requirement. He probably is not a qualifying relative because of the gross income test. The cousin apparently meets all requirements of the qualifying relative category; the relationship test is satisfied by the member-of-the-household rule. 8. (LO 4) a. Heather is a qualifying child to all three parties. b. As the parent, the mother takes precedence. If the mother waives her right to claim Heather as a dependent, then either the grandmother or the uncle―whoever has the higher AGI―will have the right to claim Heather as a dependent. 9. (LO 4) An ex-spouse can qualify as a dependent under the member-of-the-household rule for the qualifying relative category except in the year of the divorce. This explains Caden’s actions with reference to Lily for years 2023 and 2024. 10. (LO 4) Under a multiple support agreement, Isabella, Emma, or Jacob can claim either (or both) of their parents as dependents. Jacob is suggesting that his sisters each claim one of their parents as a dependent via a multiple support agreement.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

11. (LO 4) Mark will prevail because custody (not support) controls in a divorce setting. 12. (LO 4) Mario should encourage his parents and two aunts to make the move to Mexico. To be claimed as a dependent, the individual must be a U.S. citizen, a U.S. resident, or a resident of Canada or Mexico for some part of the calendar year in which the taxpayer’s year begins. 13. (LO 5) a. As a U.S. citizen, Casey must file a Federal income tax return. b. If the parties make an election under § 6013(g). Although such an election allows Casey to file a joint return, it subjects all of Michael’s foreign income to U.S. taxation. 14. (LO 4, 5) a. If the taxpayer meets the support test, he can claim head-of-household filing status as long as at least one of his parents is his dependent. This seems unlikely, however, because their purchase of an automobile is part of their support. At a minimum, the taxpayer must have contributed more than $62,000 toward total support. b. Is the stay in the nursing home temporary or permanent? If the father can be expected to return to the taxpayer’s home, she qualifies for head-of-household filing status. If the stay is permanent, then she will need to pay more than half of her father’s nursing home costs. c. Head-of-household filing status is available because the son is a dependent under the qualifying child category (the gross income test does not apply). d. Head-of-household filing status is not available. Due to the age test, the son is not a qualifying child. The son is not disabled or a full-time student. Due to the gross income test, the son does not satisfy the requirements of a qualifying relative. e. Normally, a married taxpayer cannot use head-of-household filing status. However, if the taxpayer qualifies as an abandoned spouse, this filing status is appropriate. f.

Head-of-household filing status is not available. The daughter is not a member of the taxpayer’s household.

Head-of-household status is not available because the friend, although a dependent, does not meet the relationship test.

15. (LO 5) Once the two-year surviving spouse period ends, the surviving spouse may still be maintaining a household for a dependent child. If this is the case, such a taxpayer meets the requirements for head-of-household filing status. 16. (LO 6) a. The Tax Table method is structured on a taxable income range (e.g., $30,000 to $30,050). Using the Tax Table method, the tax is determined on the midpoint (e.g., $30,025) of the range. Thus, if the taxable income is more or less than this amount, the tax will differ.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

b. The Tax Table must be used except in certain limited situations (e.g., taxable income of $100,000 or more). 17. (LO 7) a. The kiddie tax does not apply to earned income. b. The kiddie tax does not apply unless unearned income exceeds $2,600 in 2024 ($2,500 in 2023). c. The kiddie tax does not apply. The age coverage is under 19 or a full-time student under age 24. d. The kiddie tax does not apply if the child is married and files a joint return. e. If the parental election is made, the child need not file a return. f.

For married parents filing separate returns, the parent with the greater taxable income is the applicable parent.

COMPUTATIONAL EXERCISES 18. (LO 2) Brett’s $2,100 is unearned income. As a result, he is allowed the minimum standard deduction of $1,300. Abby’s $2,100 is earned income, so she is allowed a $2,550 [$2,100 (earned income for the year) + $450] standard deduction. 19. (LO 2) a. $1,850. When filing her own tax return, Ellie is limited to the greater of $1,300 or $1,850 (the sum of the earned income for the year plus $450). b. $32,300. A taxpayer who is age 65 or over or blind in 2024 qualifies for an additional standard deduction of $1,550 or $1,950, depending on filing status. Ruby and Woody’s standard deduction is $29,200 (married filing jointly) plus the additional $1,550 for Ruby being age 65 or older and another $1,550 for Woody’s being age 65 or older. c. $3,250. When filing her own tax return, Shonda is limited to the greater of $1,300 or $950 (the sum of the $500 of earned income for the year plus $450). This limitation applies only to the basic standard deduction. A dependent who is 65 or older or blind is also allowed the additional standard deduction amount on his or her own return. As a result, Shonda’s standard deduction is $3,250 ($1,300 + $1,950). d. $0. Frazier is ineligible to use the standard deduction and must itemize because he is married filing a separate return when his spouse itemizes deductions. 20. (LO 5, 8) a. If either spouse itemizes deductions from AGI, the other spouse also must itemize. Consequently, Paul’s suggestion is not a good one.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

b. Presuming that they file separately and itemize, their total deduction is $18,500 ($16,000 + $2,500). If they claim the standard deduction, $29,200 ($14,600 + $14,600) is allowed. The standard deduction is the same amount ($29,200) for a joint return. As a result, the standard deduction is the better choice. 21. (LO 6) The basic tax rate structure is progressive, with current rates ranging from 10% to 37%. Since 2024 Tax Tables have not yet been released, the solution is determined using the 2024 Tax Rate Schedules (Appendix A). Several terms are used to describe tax rates. The rates in the Tax Rate Schedules are often referred to as statutory (or nominal) rates. The marginal rate is the highest rate applied in the tax computation for a particular taxpayer. The average rate is equal to the tax liability divided by taxable income. a. Chandler: Using the rates for a single taxpayer, her tax liability is $19,131.1 Her marginal rate is 24%. Her average rate is 17.6% ($19,131 ÷ $108,700). b. Lazare: Using the rates for filing as a head of household, his tax liability is $7,681.2 His marginal rate is 22%. His average rate is 11.8% ($7,681 ÷ $65,100). $108,700 − $100,525 = $8,175. $8,175 × 24% = $1,962. $1,962 + $17,168.50 = $19,131 (rounded up).

$65,100 − $63,100 = $2,000. $2,000 × 22% = $440. $440 + $7,241 = $7,681.

22. (LO 7) In 2024, net unearned income of a dependent child is computed as follows: Unearned income Less: $1,300 Less: The greater of •

$1,300 of the standard deduction.

the amount of allowable itemized deductions directly connected with the production of the unearned income. Equals: Net unearned income •

If net unearned income is zero (or negative), the child’s tax is computed without using the parents’ rate. If the amount of net unearned income (regardless of source) is positive, the net unearned income is taxed at the parents’ rate. The child’s remaining taxable income (known as nonparental source income) is taxed at the child’s rate. Jack’s net unearned income is $2,300, computed as follows: Unearned income: $4,900 Less: $1,300 Less: $1,300 of the standard deduction Equals: $2,300

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

The allocable parental tax is $491, computed as follows: Christian and Danielle’s taxable income: $94,150 Plus: Jack’s net unearned income: $2,300 Revised taxable income: $96,450 Tax on revised parental income: $11,3251 Less: Tax on the parental income: $10,8342 Allocable parental tax: $491 Jack’s taxable income: Adjusted gross income: $4,900 Less: Standard deduction: $1,300 (limited) Equals: Taxable income: $3,600 Less: Net unearned income: $2,300 Nonparental source income: $1,300 Tax on $1,300 is $130 ($1,300 × 10%). Jack’s total tax is $621 ($491 + $130). Note: It does not matter that Jack’s unearned income was from property received from a relative rather than from his parents; the “kiddie tax” still applies. Tax Computations: 1

$96,450 − $94,300 = $2,150. $2,150 × 22% = $473. $473 + $10,852 = $11,325. $94,150 − $23,200 = $70,950. $70,950 × 12% = $8,514. $8,514 + $2,320 = $10,834.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

PROBLEMS 23. (LO 1) a. AGI Less: Itemized deductions (greater than standard deduction) Taxable income

$125,000 (32,000) $ 93,000

b. AGI Less: Standard deduction (head of household) Taxable income

$ 80,000 (2 1,900) $ 58,100

c. AGI Less: Standard deduction (surviving spouse) Taxable income

$ 76,800 (29,200) $ 47,600

d. AGI Less: Standard deduction (head of household) Taxable income

$ 58,000 (21,900) $ 36,100

e. AGI Less: Itemized deductions (greater than head-of-household standard deduction) Taxable income

$ 95,400 (23,200) $ 72,200

24. (LO 1) Salary Interest on bonds Alimony received Gain from sale of stock IRA contribution AGI Standard deduction (single) Taxable income

$ 85,000 1,100 6,000 3,000 (7,000) $ 88,100 (14,600) $ 73,500

The alimony payments, bond interest, and capital gain are includible in gross income (i.e., are taxable). The gift is a nontaxable exclusion. The IRA contribution is a for AGI deduction. The gambling losses are not deductible. 25. (LO 1) Salary Interest on CD Dividend AGI Standard deduction (head of household) Taxable income

$ 80,000 2,000 2,200 $ 84,200 (21,900) $ 62,300

The interest ($3,000) on the City of Boston bonds is an exclusion (i.e., not taxable). Also excluded from gross income are the life insurance proceeds ($200,000) and the inheritance ($100,000). The loan repayment ($5,000) is a nontaxable return of capital. Aiden’s itemized deductions total $19,500; the head-of-household standard deduction ($21,900) provides a larger from AGI deduction.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

26. (LO 2) a. $14,600. Although $14,400 (earned income) + $450 = $14,850, the amount allowed cannot exceed the standard deduction available in 2024 for single taxpayers. b. $5,150. $4,700 (earned income) + $450. c. $1,450. The greater of $1,300 or $1,450 [$1,000 (earned income) + $450]. d. $1,300. The greater of $1,300 or $950 [$500 (earned income) + $450]. e. $5,600. $3,200 (earned income) + $450 + $1,950 (additional standard deduction). 27. (LO 4) a. b. c. d. e. f. g. h. i. j.

Characteristic Taxpayer’s son has gross income of $7,000. Taxpayer’s niece has gross income of $3,000. Taxpayer’s uncle lives with him. Taxpayer’s daughter is 25 and disabled. Taxpayer’s daughter is age 18, has gross income of $8,000, and does not live with him. Taxpayer’s cousin does not live with her. Taxpayer’s brother does not live with her. Taxpayer’s sister has dropped out of school, is age 17, and lives with him. Taxpayer’s older nephew is age 23 and a full-time student. Taxpayer’s grandson lives with her and has gross income of $7,000.

Qualifying Child Test Gross income—Not Applicable Gross income—Not Applicable Relationship—Not Met Age—Met Residence—Not Met Gross income—Not Applicable Relationship—Not Met Residence—Not Met Residence—Not Met

Qualifying Relative Test Gross income—Not Met

Relationship—Met Residence—Met Age—Met Relationship—Met Age—Not Met Relationship—Met Residence—Met

Relationship—Met

Gross income—Met Relationship—Met Age—Not Applicable Gross income—Not Met Relationship—Not Met Relationship—Met

Relationship—Met Relationship—Met Gross income—Not Met

28. (LO 3, 4) a. Two. Libby is a qualifying child, so her gross income does not matter. Sam is not a qualifying child—although a full-time student, he is not under age 24. However, Sam falls within the qualifying relative category. He passes the gross income test because the tuition portion of a scholarship is nontaxable. b. One. Clint cannot qualify as a member of Audry’s household in the year of the divorce. Olive meets the relationship test. c. Two. Because Andy is a qualified child, he is not subject to the gross income test. Paige meets the gross income requirements of a qualifying relative. d. One. As a qualifying child, Andy is not subject to the gross income test. In a community property situation, however, Paige is treated as having $5,200 (one-half of $10,400) in gross income. Thus, she does not meet the gross income test and cannot be a qualifying relative.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

29. (LO 3, 4) a. Two. The parents qualify as dependents under the Mexico/Canada exception. b. One. Pablo’s father does not qualify because he is a citizen and resident of Panama; as a resident of the United States, Pablo’s mother does qualify. c. Two. The parents qualify because they are U.S. citizens. d. One. Under a special exception, an adopted child need not be a citizen or resident of the United States (or contiguous country) as long as his or her principal residence is with a U.S. citizen. 30. (LO 3, 4) a. Three. The niece is in the qualifying child category. The cousin and son are not, due to the relationship and age tests. They both fall within the qualifying relative category. b. Two. Both persons fall within the qualifying relative category. The stepmother meets the relationship test, and the family friend’s son is a member of the taxpayer’s household. c. None. Mariana is not a qualifying child under the exception to the citizenship or residency test. Raul is not her adoptive father. d. Three. All fall within the qualifying relative category and each meets the gross income test. The mother- and brother-in-law satisfy the relationship test. The exhusband is a member of the household, and he can qualify except in the year of the divorce. The brother-in-law’s age and non-student status have no bearing on the dependency issue. 31. (LO 4) a. Jenny is a qualifying child as to all three parties. As a result, the father, uncle, and grandmother are eligible to claim her as a dependent. b. In this tiebreaker situation, the father (as parent) takes precedence. If the father forgoes claiming Jenny as a dependent, the uncle is next in order of precedence, due to a higher AGI. 32. (LO 4, 8) a. Son, niece, and brother. The cousin and the family friend do not meet the relationship test. b. No. The eligible parties can designate who will claim the dependents as they choose. c. If the eligible person who is selected to claim the dependent also pays the medical expenses, that person can claim the medical expenses.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

33. (LO 3, 7) a. Wages Money market interest Bond interest (City of Chicago bond interest is tax-exempt.) Gross income Less: Standard deduction* Taxable income

$6,250 850 –0– $7,10 0 (6,700) $ 400

b. Net Unearned Income Calculation: Money market account interest City of Chicago bond interest Total unearned income Minus: $1,300 + $1,300 standard deduction Net unearned income

$ 850 –0– $ 850 (2,600) $ –0–

Income taxed at Taylor’s rate

$ 400

Total tax ($400 × 10%)**

*A dependent’s standard deduction is limited to the greater of $1,300 or the sum of his or her earned income plus $450 (for Taylor, this is $6,700; $6,250 + $450). **Because Taylor’s unearned income is not more than $2,600, the “kiddie tax” does not apply and her tax is determined using the Single Tax Rate Schedule. 34. (LO 4, 8) a. Regardless of where the parties reside, the damage of the joint return needs to be undone. The joint return test applies to both the qualifying child and qualifying relative categories of dependents. The situation can be rectified by filing separate returns on or before April 15, 2025. In Louisiana, half of Stella’s income, or $5,500 (50% × $11,000), is assigned to John. Being a qualifying child, Stella can be claimed as a dependent. John, however, is subject to the gross income test contained in the qualifying relative category. Because $5,500 exceeds $5,050, John cannot be claimed as a dependent. b. As noted in part a., the joint return problem needs to be resolved. In New Jersey, none of Stella’s income is assigned to John. Consequently, John now meets the gross income test of a qualifying relative. Stella also can be claimed as a dependent because the gross income test does not apply to the qualifying child category.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

35. (LO 1, 2, 3, 4, 5, 6) Salary Loss on sale of stock Cash prize AGI Less: Standard deduction (surviving spouse) Taxable income

$81,800 (2,000) 4,000 $83,800 (29,200) $54,600

Tax on $54,600 using Surviving Spouse Tax Rate Schedule: $2,320 + 12%($54,600 − $23,200) = $6,088 In addition, Charlotte qualifies for the following child and dependent tax credits: 4 children ($2,000 each) $ 8,000 2 dependents ($500 each) 1,000 Total $ 9,000 Charlotte’s father is a dependent; he does not fail the gross income test because taxexempt income is not counted. There is no phaseout of the child and dependent tax credits because Charlotte’s AGI does not exceed $400,000 (Charlotte is a surviving spouse). Of the $8,000 child tax credit, $6,800 is refundable ($1,700 × 4). This $6,800 refundable amount is less than 15% of Charlotte’s earned income in excess of $2,500 [($81,800 − $2,500) × 15% = $11,895]. None of the dependent tax credit is refundable. 36. (LO 1, 2, 3, 4, 5, 6) Gross income Contribution to traditional IRA AGI Less: Standard deduction (head of household) Taxable income

$98,500 (7,000) $91,500 (21,900) $69,600

Tax on $69,600 using Head-of-Household Tax Rate Schedule: $7,241 + 22%($69,600 − $63,100) = $8,671 In addition, Morgan may claim a $1,000 dependent tax credit for Tammy and Jen ($500 × 2). Although Tammy is not a relative, she is a member of Morgan’s household. Jen meets the relationship test. Morgan may not claim a dependent tax credit for Jerold. Jerold meets the relationship test and citizenship test (as a resident of Canada), but he is not a U.S. citizen or a resident. None of the $1,000 dependent tax credit is refundable. 37. (LO 5) a. Patricia is not required to file. Her gross income is less than $14,600, and her net earnings from self-employment are less than $400. b. Mike does not need to file because his gross income of $14,150 is less than the $16,550 filing requirement ($14,600 + $1,950). If, however, any income taxes were withheld from his wages, Mike should file a tax return to obtain a refund even though filing is not required. c. Ronald is not required to file. His gross income of $6,800 is less than his $7,250 standard deduction (earned income plus $450). However, Ronald should file a return to obtain a tax refund if any income taxes were withheld from his wages.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

d. Sam and Lana are not required to file because their gross income of $26,250 is less than the $32,300 filing requirement ($29,200 + $1,550 + $1,550). e. Quinn must file a return. He has unearned income of more than $1,300 and no additional standard deductions. 38. (LO 5, 6, 8) If Sarah and Brandi do not marry, their tax status is as follows: Gross income and AGI Standard deduction (single) Taxable income

Sarah $ 11,000 (14,600) $ –0–

Brandi $62,000 (14,600) $47,400

Tax on $47,400 using the Single Tax Rate Schedule is $5,481 [$5,426 + 22%($47,400 − $47,150)]. Thus, $0 (Sarah) + $5,481 (Brandi) = $5,481 total tax for not being married. If Sarah and Brandi do marry: Gross income ($11,000 + $62,000) Standard deduction (married, filing jointly) Taxable income

$73,000 (29,200) $43,800

Tax on $43,800 using the Married Filing Jointly Tax Rate Schedule is $4,792 [$2,320 + 12%($43,800 − $23,200)]. By getting married and filing a joint return, $689 ($5,481 − $4,792) is saved. 39. (LO 5) a. Winston qualifies for head-of-household filing status as long as one parent is his dependent. b. Winston must use single filing status. Except in the case of parents, head-of-household status requires that the dependent be a member of the taxpayer’s household. c. The dependent must meet the relationship test; Ward does not meet this test. As a result, Winston must use single filing status. d. Winston can qualify for head of household if the mother-in-law is his dependent. He does not meet the requirements of a surviving spouse because a mother-in-law is not a child. e. Because Winston is still married, he cannot use head-of-household filing status. (He does not satisfy the requirements of an abandoned spouse—a mother-in-law is not a child.) Consequently, Winston must use married filing separately filing status. 40. (LO 4, 5) a. For 2022, Becca’s filing status is married filing jointly. Because she is the executor of Christopher’s estate, she can consent on his behalf to file jointly. Being under 19 years of age, Dylan is a dependent as a qualifying child. b. For 2023, Becca’s filing status is surviving spouse. Dylan is not a qualifying child (due to the age test), but is a qualifying relative (the gross income test is waived when determining surviving spouse status).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

c. For 2024, Becca’s filing status is surviving spouse. She can claim Dylan as a dependent. Dylan is a qualifying child—although not under age 19, he is a full-time student and under age 24. The gross income test does not apply to a qualifying child. 41. (LO 3, 4, 5) a. For 2023, Jerold can file a joint return. As executor of Nadia’s estate, he can consent to file a joint return on her behalf. For 2024, Jerold can qualify as a surviving spouse. Travis is a qualifying child due to his student status, and Macy is a qualifying relative—her gross income of $3,500 (50% × $7,000) meets the gross income test. As a result, Jerold has two dependents. b. The answer as to filing status does not change: joint return for 2023 and surviving spouse for 2024. Kansas is a common law state, so all of the $7,000 Macy earns is assigned to her. Travis is a qualifying child. Macy will not be a dependent under the qualifying relative category because of the gross income test. As a result, Jerold has only one dependent (Travis). 42. (LO 1, 3, 7) Unearned income Minus: $1,300 base amount + $1,300 standard deduction Unearned income taxed at parents’ rate

$4,600 (2,600) $2,000

Paige’s parents are in the 22% bracket, so her unearned income would generate $440 of tax (22% × $2,000). Computation of Paige’s taxable income and tax: Earned income Interest income Gross income and AGI Less: Standard deduction [greater of $1,300 or $3,900 (earned income) + $450] Taxable income Less: Unearned income taxed at parents’ rate Income taxed at Paige’s rate Paige’s tax rate Tax at Paige’s rate

$3,900 4,600 $8,500 (4,350) $4,150 (2,000) $2,1 50 × 10% $ 215

Paige’s total tax: $440 (unearned income taxed at parents’ rate) + $215 (taxed at Paige’s rate) = $655. 43. (LO 1, 3, 7) a. Earned income Interest income Gross income and AGI Less: Standard deduction [greater of $1,300 or $3,850, $3,400 (earned income) + $450] Taxable income

$3,400 4,800 $8,200 (3,850) $4,350

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

b. Taxed at parents’ rate: Unearned income Less: $1,300 + $1,300 Net unearned income (taxed at parents’ rate) Taxed at Terri’s rate: Taxable income Less: Amount taxed at parents’ rate Taxed at Terri’s rate

$4,800 (2,600) $2,200 $4,350 (2,200) $2,1 50

c. The parental election cannot be made because Terri’s income is not solely from interest and dividends. 44. (LO 8) a. By concentrating the payment of three years of charitable contributions (2023, 2024, and 2025) into one year, the Bateses will be able to itemize their deductions from AGI in 2024. Otherwise, their itemized deductions (normally $24,000) are of no benefit because they do not exceed the standard deduction ($27,700 in 2023; $29,200 in 2024; likely higher in 2025, although not yet determined). b. Since the $24,000 of normal itemized deductions already includes one year of church pledge payments, the additional payments of $10,000 ($5,000 for 2023 and $5,000 for 2025) yield itemized deductions of $34,000 ($24,000 + $10,000) for 2024. This exceeds the standard deduction by $4,800 ($34,000 − $29,200) that the Bateses would have claimed. As a result, the tax savings they earn by concentrating the charitable contributions becomes $1,152 (24% × $4,800). The Bateses will use the standard deduction in 2025 (assuming that nothing else changes). c.

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 February 22, 2024 Mr. and Mrs. Tom Bates 8212 Bridle Court Reston, VA 20194 Dear Mr. and Mrs. Bates: In response to your inquiry regarding the Federal income tax consequences of consolidating your charitable contributions for 2023, 2024, and 2025 into a single year (2024), here is a brief summary of the outcomes: •

Because individual taxpayers are presumed to be on the cash basis, all cash expenditures during a year will be evaluated in determining deductibility. In this case, combining the three $5,000 contributions into a single year makes sense from an income tax perspective.

•

By combining all three payments in 2024, you will be able to itemize your deductions in that year while using the standard deduction amount in 2025.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

•

This $10,000 of additional contributions in 2024 (the $5,000 payments for 2023 and 2025) means that you will have total itemized deductions of $34,000 (which exceeds the 2024 married filing jointly standard deduction amount by $4,800).

•

By consolidating these contributions in 2024, your tax savings will be $1,152 (the $4,800 of total itemized deductions in excess of the standard deduction times your marginal tax rate of 24%).

If I can be of further assistance to you in this matter, please do not hesitate to contact me. Sincerely, Heywood R. Floyd Partner

TAX RETURN PROBLEMS 45. Salaries ($60,000 + $43,000) Interest income (Note 1): Ford Motor Company bonds Ally Bank CD Child support (Note 2) Gift from parents (Note 3) Injury settlement (Note 4) Lottery winnings (Note 5) Federal income tax refund (Note 6) IRA contribution (Note 7) Adjusted gross income (AGI) Itemized deductions from AGI Medical [$7,200 − (7.5% × $98,100)] Taxes ($3,600 + $4,200) Interest on home mortgage Charitable contributions Life insurance premiums, traffic fines, political contributions, funeral expenses (Note 8) Standard deduction (married, filing jointly) (Note 9) Taxable income Tax on taxable income of $70,900 based on 2023 Married Filing Jointly Tax Table Less: Withholdings ($3,900 + $1,600) Less: Child and dependent tax credit (Note 10) Net tax payable (or refund due)

$103,000 $ 1,100 400

1,500 –0– –0– –0– 600 –0– (6,500) $ 98,600

–0– 7,800 6,000 3,600

–0– $17,400

$ 5,500 3,000

(27,700) $ 70,900 $ 8,071 ($

(8,500) 429)

Completed tax forms for this problem are available on the Cengage Instructor Center.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

Notes (1)

Interest on state and local bonds is an exclusion from gross income. See Exhibit 3.1 in the text.

(2)

Child support is an exclusion from gross income, but alimony is not. The $7,200 that John Allen paid is clearly child support because any alimony obligation terminated when Wanda remarried. See Exhibits 3.1 and 3.2 in the text.

(3)

Gifts are exclusions from gross income (Exhibit 3.1 in the text).

(4)

Damages for a physical personal injury are exclusions from gross income (Exhibit 3.1) unless they are punitive in nature (Exhibit 3.2). There is no reason to assume that any of the $90,000 settlement is punitive because the matter was never litigated in a court.

(5)

Lottery winnings are included in gross income (Exhibit 3.2). If the taxpayer has substantiation, losses can be claimed to the extent of gains.

(6)

Federal income tax payments are not deductible; as a result, any refunds are not included in income.

(7)

A contribution to a traditional IRA is a deduction for AGI.

(8)

Life insurance premiums, traffic fines, political contributions, and funeral costs are not deductible.

(9)

The Deans will use the married filing joint standard deduction (it exceeds their itemized deductions).

(10)

Wanda may claim the children as dependents because she has custody and did not issue a Form 8332 waiver in favor of John Allen (the father). Because Penny is a qualifying child, she is not subject to the gross income limitation. (In terms of age, Penny falls under the student exception.) The facts do not indicate whether Kyle is a student, but this status is not necessary because he has met the age test (i.e., under 19) for a qualifying child. The Deans are able to claim a $2,000 child tax credit for Kyle (he is under age 17 in 2023), a $500 dependent tax credit for Penny, and a $500 dependent tax credit for Wayne (Wanda’s father). Since their AGI does not exceed $400,000, there is no phaseout of the child and dependent tax credits. In 2023, $1,600 of the child tax credit is refundable (this is less than 15% of their earned income less $2,500); the dependent tax credit is not refundable.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

46. Part 1—Tax Computation Salary Interest income— Omni Bank Boone State Bank City of Springfield bonds (Note 1) Inheritance (Note 2) Life insurance proceeds (Note 3) Sale of stock held as an investment (Note 4) Estate sale (Note 5) Federal income tax refund (Note 6) Adjusted gross income (AGI) Itemized deductions from AGI (greater than $27,700 married, filing jointly standard deduction) Medical [$13,500 − (7.5% × $78,400)] Taxes— State income tax $4,200 Property tax 4,500 Interest on home mortgage Charitable contributions (Note 7) Taxable income

$ 80,000 $

300 1, 10 0 –0–

1,400 –0– –0– (3,000) –0– –0– $ 78,400

$7,620 8,700 5,600 7,200

Tax on taxable income of $49,280 based on 2023 Married Filing Jointly (Surviving Spouse) Tax Table (Note 8) Less: Withholdings $3,900 Less: Dependent tax credit (Note 9) 1 ,500 Net tax payable (or refund due)

(29,120) $ 49,280 $

5,473

(5,400) 73

Completed tax forms for this problem are available on the Cengage Instructor Center. Notes (1)

Interest on state and local bonds is excluded from gross income. See Exhibit 3.1 in the text.

(2)

Inheritances are excluded from gross income. See Exhibit 3.1 in the text.

(3)

Life insurance proceeds are nontaxable. See Exhibit 3.1 in the text.

(4)

Logan has a realized loss of $5,000 [$80,000 (selling price) − $85,000 (cost basis)] from the sale of the stock. Absent any offsetting gains, however, he can deduct only $3,000 against ordinary income. The remaining $2,000 loss can be carried over to 2024.

(5)

The basis of the property inherited is its fair market value on the date of the decedent’s death. The basis of any other property that was sold is its cost (see Chapter 13 in the text). Consequently, the estate sale most likely resulted in a realized loss. Because the loss is personal, it cannot be recognized. Thus, the estate sale results in no income tax consequences.

(6)

A Federal income tax refund is a return of a nondeductible expenditure; as a result, it is nontaxable.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

(7)

Charitable contributions are deductible in the year paid ($3,600 + $3,600 = $7,200). The year for which they were pledged does not matter.

(8)

Logan is a surviving spouse for filing purposes.

(9)

Helen and Mia meet the qualifying relative tests. Asher is a qualifying child (under age 24 and a full-time student), so he is not subject to the gross income test. Logan is able to claim a $1,500 dependent tax credit (3 × $500; for Asher, Mia, and Helen). Neither Mia nor Asher qualifies for the child tax credit; neither is under age 17 in 2023. The dependent tax credit is not subject to phaseout (Logan’s AGI does not exceed $400,000), and it is not refundable.

Part 2—Follow-Up Advice SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 February 28, 2024 Logan B. Taylor 4680 Dogwood Lane Springfield, MO 65801 Dear Mr. Taylor: In response to your inquiry regarding the Federal income tax situation for 2024, the news is not good. The following developments will cause an increase in your taxes: •

Your filing status moves from surviving spouse to single. The result is a shift from the lowest to the highest progressive tax rates.

•

The stock loss deduction is $2,000, or $1,000 less than last year.

•

For various reasons, your children and mother no longer qualify as dependents. As a result, the dependent tax credit ($1,500 in 2023) will not be available to you in 2024.

•

Because of less medical expense and no interest and charitable deductions, your itemized deductions will decrease. As a result, you will use the single standard deduction of $14,600.

Based on last year’s data, an estimate of your Federal income tax liability for 2024 is $9,309* (or $3,836 more than your 2023 Federal tax liability of $5,473). If I can be of further assistance to you in this matter, please do not hesitate to contact me. Sincerely, Eduardo Rodriguez Partner *$81,400 (AGI without $3,000 capital loss deduction) − $2,000 (capital loss carryover) = $79,400 (AGI) − $14,600 (single standard deduction) = $64,800 (taxable income). Tax is $9,309 [$5,426 + 22%($64,800 − $47,150)] using the 2024 Tax Rate Schedules for single taxpayers.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

RESEARCH PROBLEMS 1.

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 March 6, 2025 Mr. Brett Ouray 16 Lahinch Chicago, IL 60608 Dear Brett: This letter is in response to your inquiry about which filing status is most appropriate for you in the current tax year. Generally, married taxpayers who do not file a joint return must file as married filing separately. However, there exists a special classification called abandoned spouse that allows a married person to be treated as being single. Single persons can qualify for head-of-household filing status. To be considered an abandoned spouse (in other words, to be considered not married for tax purposes), you must satisfy all of the following requirements: (1)

You maintain a household that for more than half the year is the principal living place of a child whom you claim as a dependent.

(2)

You furnish more than half the cost of maintaining the home.

(3)

Your spouse was not a member of the household for the last six months of the year.

Although in your situation the first two requirements are satisfied, the third requirement is likely not satisfied. Both the IRS and the courts have concluded that taxpayers must live in separate residences to be considered living apart. Despite the fact that you and your wife are estranged, because you live in the same house, you will not be considered unmarried for tax purposes. As such, given that you are not yet divorced, the appropriate filing status in the current year would be married filing jointly. If you and your wife are sufficiently estranged that it would not be possible to file jointly, the appropriate filing status would then be married filing separately. If I can be of further assistance to you in this matter, please feel free to contact me. Sincerely, Janice Dodd, CPA Instructor Note: Code § 7703(b) addresses married taxpayers who live apart and specifies the requirements listed above. Although § 7703(b) does not provide much detail about what being a member of a household involves, Reg. § 1.7703–1(b)(5) clarifies that an individual’s spouse is not a member of the household during a taxable year if such household does not constitute such spouse’s place of residence at any time during the year. The facts in the problem closely mirror the facts in Keith Chiosie, 79 TCM 1812, T.C.Memo. 2000–117. The opinion in this case confirms that not to be considered members © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

of the same household, taxpayers must live apart. The opinion provides a helpful discussion of how courts have interpreted the “living apart” requirement and references other cases that also specify that there must be geographic distance between the taxpayers to satisfy the third requirement. 2. a. The Bakers have two dependents: Florence and Darin. With regard to Janet’s parents, the following table summarizes the components involved: Support Provided Funds spent on clothing, transportation, and recreation (1/2 × $8,000) Fair rental value of lodging (1/7 × $14,000) Share of food (1/7 × $10,500) Dental bills Life insurance premium Parents’ total support

Calvin

Florence

$4,000 2,000 1,500 — — $7,500

$4,000 2,000 1,500 1,000 — $8,500

Of Calvin’s total support of $7,500, the Bakers provide only $3,500 ($2,000 + $1,500), which is not more than 50%. Life insurance premiums are not considered to be an item of support. In Florence’s case, however, the Bakers furnish $4,500 ($2,000 + $1,500 + $1,000), which is more than $4,250 (50% of $8,500). As a qualifying child (under age 19), Darin’s income is immaterial (as long as he is not self-supporting). Because he satisfies the age requirement, his student status does not matter. Andrea is not a qualifying child because she meets neither the age nor student test. She is not a qualifying relative because the support test is not met. The facts do not state what other types of support (e.g., clothing, recreation, medical) the Bakers pay for, but it would have to be significant for the total (including room and board) to exceed $21,000. Morgan could be a qualifying child except that she appears to be self-supporting. Furthermore, she cannot be a qualifying relative due to the support test. As was the case for Andrea, however, the facts do not reflect what other types of support (besides room and board) her parents might provide. It is unlikely that the total would exceed the $20,000 Morgan furnishes herself. b. Calvin could have been a dependent if Janet had not paid the life insurance premium. Instead, she should have applied the funds on Calvin’s behalf toward a support item (e.g., help pay for the vacation). Thus, Calvin could pay the premium from his own funds without jeopardizing the support percentage. In the case of Andrea, her parents would have had a better chance of meeting the support test if the cost of the car had not been so high. In this regard, could leasing rather than purchasing the Camaro have accomplished this result? Perhaps the Bakers could have contributed whatever portion of the cost is needed to satisfy the more-than-50% requirement for the dependency status.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

RESEARCH PROBLEMS 3 TO 7 These research problems require that students utilize online resources to research and answer the questions. As a result, solutions may vary among students and courses. You should determine the skill and experience levels of the students before assigning these problems, coaching where necessary. Encourage students to use reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax professionals, academics, think tanks, and political outlets to research their answers. 3. Students should be able to locate IRS data by going to the web page: irs.gov/statistics/soi-tax-stats-individual-statistical-tables-by-size-of-adjustedgross-income Under the “All Returns: Sources of Income, Adjustments Deductions and Exemptions, and Tax Items” panel, the 2021 data is contained in the following downloadable file: 21in14ar.xls. Data for other years also are available, so this assignment could be made more robust by asking students to analyze data across several years. 4. Form 2120 is the multiple support declaration form. Technically, no one has to sign the form; the taxpayer claiming the dependent must have a signed statement from each other person eligible to claim the taxpayer in question as a dependent. A multiple support agreement can only be used to claim a qualifying relative as a dependent. 5. The form is used to request innocent spouse relief. The form should be filed as soon as the taxpayer (the innocent spouse) becomes aware of a tax liability for which he or she believes only his or her spouse or former spouse should be held responsible. 6. On irs.gov, search for the following term: nonresident alien filing. The website irs.gov/individuals/international-taxpayers/taxation-of-nonresident-aliens provides details about the taxation of nonresident aliens. 7. Student responses will vary. In general, students will find that the current versions of the AI tools often provide incomplete or incorrect answers. Evolution of the AI tools may lead to more complete and accurate results over time. During the development process for the 2025 edition, ChatGPT did not answer any of the selected questions correctly. For example, in the kiddie tax problem, it used an incorrect standard deduction amount when determining net unearned income. It failed to use the larger of the standard deduction or itemized deductions when computing taxable income for the items in Problem 23 and did not compute the correct standard deduction amounts for the items in Problem 26.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

CHECK FIGURES 18. 19.a. 19.b. 19.c. 19.d. 20.a. 20.b. 21.a. 21.b. 22. 23.a. 23.b. 23.c. 23.d. 23.e. 24. 25. 26.a. 26.b. 26.c. 26.d. 26.e. 27.a. 27.b. 27.c. 27.d. 27.e. 27.f. 27.g. 27.h. 27.i. 27.j. 28.a. 28.b. 28.c. 28.d.

Brett has $2,100 unearned income. $1,850. $32,300. $3,250. $0. Both spouses must itemize. Claim standard deduction. $19,131; 24%; 17.6%. $7,681; 22%; 11.8%. $2,300; $491; $621. $93,000. $58,100. $47,600. $36,100. $72,200. $73,500. $62,300. $14,600. $5,150. $1,450. $1,300. $5,600. QC: NA; QR: Not met. QC: NA; QR: Met. QC: Not met; QR: Met. QC: Met; QR: NA. QC: Residence: Not met; QR: Not met. QC: No tests met; QR: Not met. QC: Not met; QR: Met. QC: All tests met; QR: Met. QC: Age: Not met; QR: Met. QC: All tests met; QR: GI: Not met. Two. One. Two. One.

29.a. 29.b. 29.c. 29.d. 30.a. 30.b. 30.c. 30.d. 31.a. 32.a. 33.a. 33.b. 35. 36. 37.a. 37.b. 37.c. 37.d. 37.e. 38. 39.a. 39.b. 39.c. 39.d. 39.e. 40.a. 40.b. 40.c. 41.a. 41.b. 42. 43.a. 43.b. 43.c. 44.b. 45. 46.

Two. One. Two. One. Three. Two. None. Three. All three are eligible. Son, niece, and brother. $400. $40. $6,088. $8,671. Patricia is not required to file. Mike is not required to file. Ronald is not required to file. Sam and Lana are not required to file. Quinn is required to file. Joint return saves $689. Head of household. Single. Single. Potentially head of household. Married filing separately. 2022 married filing jointly. 2023 surviving spouse. 2024 surviving spouse. 2023 filing jointly; 2024 surviving spouse. 2023 filing jointly; 2024 surviving spouse. Taxable income $4,150; tax $655. $4,350. $2,150; $2,200. Parental election cannot be made. Saves $1,152. Refund due $429. Part 1—tax due $73. Part 2—income tax increases by $3,836.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

SOLUTIONS TO ETHICS & EQUITY FEATURES Whose Qualifying Child Is He? (p. 3-26). Until recently, the procedure suggested by the Rands would have worked. However, Congress changed the Internal Revenue Code to prohibit this [§ 152(c)(4)(C)]. Under current law, another eligible taxpayer may claim a person as a qualified child only if the person has an adjusted gross income (AGI) higher than the highest AGI of any of his or her parents. This new provision eliminates Belinda because her AGI ($15,000) is not higher than her parent’s AGI ($400,000). As a result, regardless of the Rands’ willingness to waive claiming him, Henry remains their qualifying child. Abandoned Spouse? (p. 3-33). A married individual is not treated as unmarried under the abandoned spouse rules if the individual’s spouse occupies the same residence, even if they maintain separate bedrooms and bathrooms {see, for example, Lyddan v. U.S. [82−2 USTC ¶9701, 51 AFTR 2d 83−808 (D.Ct., CT, 1982), aff’d 83−2 USTC ¶9706, 52 AFTR 2d 83−6254, 721 F.2d 873 (CA−2), cert denied 104 S.Ct. 2656 (1984)]}. The same is true if one spouse moves into the basement while the other spouse and children reside in the upper levels (see Ebrahim Elsawah, T.C. Summary Opinion 2004−33). According to Lyddan, there is a need for a “bright line” test that does not depend on a factual inquiry into the intimate living details of an estranged couple. Further, according to Thomas L. Dawkins (61 TCM 2667, T.C.Memo. 1991−225), Congress did not intend spouses living under the same roof to be treated as living “separated and apart.” So the question in this case is whether the detached garage would be considered “under the same roof” or “occupying the same residence.” In the Second Circuit decision in Lyddan, the court wrote: “We think the phrase requires a geographical separation and means living in separate residences.” If so, then it is highly likely that Bob and Carol are “occupying the same residence.” As such, they would be considered “married” and Carol would not qualify for head-of-household status.

SOLUTIONS TO BECKER CPA REVIEW QUESTIONS 1.

Choice “a” is correct. Bob can only file as single. Bob does not meet the criteria to file as head of household. The head-of-household filing status is available to unmarried taxpayers who maintain a household for more than half the year for an unmarried son or daughter (not required to be a dependent, but must live with the taxpayer), father or mother (must be a dependent but not required to live with the taxpayer), or other dependent relative (must live with the taxpayer). In this case, Bob’s mother does not meet the criteria to be considered his dependent. Specifically, she fails the qualifying relative gross income test. Choice “b” is incorrect. Bob’s mother is not Bob’s dependent. Therefore, he cannot file as head of household. Choice “c” is incorrect. “Qualifying single” is not an actual filing status. The filing statuses are single, head of household, married filing separately, qualifying widow(er), and married filing jointly.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

Choice “d” is incorrect. “Supporting single” is not an actual filing status. The filing statuses are single, head of household, married filing separately, qualifying widow(er), and married filing jointly. 2. Choice “c” is correct. Jane does not qualify as a dependent for her grandparents as a qualifying child or relative. With respect to her grandparents, Janeʼs scholarship is treated as support and thus Jane provides more than half of her own support ($12,000 savings + $5,000 scholarship = $17,000; $17,000 ÷ $30,000 = 0.57 = 57%). Jane does qualify as a dependent of her parents because she is under 24, a full-time student, and the scholarship does not count as support with respect to her parents. She also meets all other tests of qualifying child for her parents. Choice “a” is incorrect. The scholarship does not count as support for Jane with respect to her parents. Therefore, Jane meets all tests for qualifying child of her parents. Choice “b” is incorrect. Jane’s scholarship does count as support for Jane with respect to her grandparents. Because Jane provided more than half of her own support (see the calculation above), Jane’s grandparents cannot claim her as a qualifying child or relative. Choice “d” is incorrect. Jane is a dependent of her parents because she meets all tests for a qualifying child. Therefore, she cannot claim an exemption for herself. 3. Choice “b” is correct. The niece meets the SUPORT test for qualifying relative status. The cousin and family friend do not meet the “R” (relative) or “T” (taxpayer lives with individual) tests. All three people whom Blake supports fail the residency test for a qualifying child. Choice “a” is incorrect. The cousin does not meet the “R” (relative) or “T” (taxpayer lives with individual) tests for a qualifying relative because Blake’s cousin did not live with him for the entire year. Choice “c” is incorrect. Blake’s family friend does not meet the “R” (relative) or “T” (taxpayer lives with individual) test because Blake’s family friend does not qualify as a qualifying relative and did not live with him for the entire year. Choice “d” is incorrect. Blake’s niece meets the SUPORT tests and therefore counts as a qualifying relative. 4. Choice “b” is correct. Jeff and Rhonda may claim a total of three (3) dependents on their joint income tax return. •

Max is a qualifying child. He is full-time student under the age of 24, lives at home when he is not away for temporary absence at school, and is supported more than 50% by Jeff and Rhonda. The gross income test does not apply. Max is a dependent.

•

Jen is also a qualifying child. While she is not a full-time student, she is still under the age of 19, lives at home, and is supported over 50% by her parents. The gross income test does not apply. Jen is a dependent.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

•

Joanne is a qualifying relative. She receives all of her support from Jeff and Rhonda, makes less than the taxable gross income threshold amount in taxable income (her Social Security would not be taxable in these circumstances), does not file a joint return, and is a relative. Joanne is a dependent.

Choices “a,” “c,” and “d” are incorrect, per the above explanation. 5. Choice “c” is correct. The Grants have two dependents. Kelly is considered a qualifying child. Kelly meets the relationship test and age test. Her time away at college is counted as home for the residence test. Kelly does not provide more than half of her own support. Jake is considered a qualifying child and meets all tests. Luke fails the qualifying child test (he is not a relative). He does not meet the qualifying relative test because he did not live with the Grants for the entire year. 6. Choice “d” is correct. Ryan meets the SUPORT tests for a qualifying relative if the Chambers provide more than half of Ryan’s support. CARES Test (Qualifying Child) Close Relative Age Limit Residency and Filing Requirements Eliminate Gross Income Test Support Test

SUPORT Test (Qualifying Relative) Support (over 50%) test Under a specific amount of (taxable) gross income test Precludes dependent filing a joint tax return test Only citizens (residents of U.S./Canada or Mexico) test Relative test Taxpayer lives with individual

Ryan’s taxable income ($2,000) is under the gross income threshold amount. He doesn’t file a joint return. He is a citizen of the United States, and he lives with the Chambers for the entire year. Choice “a” is incorrect. If Ryan earns $15,000 in self-employment income, he would not meet the “U” test because his taxable income is over the gross income threshold amount. Choice “b” is incorrect. Ryan does not meet the CARES test for qualifying child. He is not a close relative and not under the age limit. Choice “c” is incorrect. The support test for the qualifying relative test states that the Chambers must pay more than half of the support of Ryan. The fact that Ryan does not provide more than half of his own support is not enough to meet the support test for qualifying relative (SUPORT). 7. Choice “b” is correct. Under a multiple support agreement, Susie, Luke, and Will are eligible to claim Joyce as a dependent because they contributed more than 10% of Joyce’s support. Choice “a” is incorrect. John did not provide more than 10% of Joyce’s support. Therefore, he is not eligible to claim Joyce as a dependent under a multiple support agreement. Choice “c” is incorrect. Under a multiple support agreement, Luke is also eligible to claim Joyce as a dependent because he contributed more than 10% of Joyce’s support.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

Choice “d” is incorrect. Under a multiple support agreement, Susie and Luke are also eligible to claim Joyce as a dependent because they contributed more than 10% of Joyce’s support 8. Choice “c” is correct. Rhett fails both the age limit and residency test for qualifying child status. Choice “a” is incorrect. Rhett is not a qualifying child. He fails both the age limit test and the residency test (CARES). Choice “b” is incorrect. Rhett is not considered a qualifying relative because his gross income exceeds the gross income threshold amount. Choice “d” is incorrect. Rhett does not have to live with Heather for the entire year to meet the qualifying relative test because he is her son. 9. Choice “d” is correct. Jonathan is a qualifying child of his parents. He meets all requirements (CARES): CARES Test (Qualifying Child) Close Relative Age Limit Residency and Filing Requirements Eliminate Gross Income Test Support Test Choice “a” is incorrect. Jonathan is a qualifying child of his parents. Qualifying child status does not have a gross income limitation. Choice “b” is incorrect. Jonathan meets the residency requirements for qualifying child because he is away at college. Choice “c” is incorrect. Jonathan’s grandparents cannot claim Jonathan as a dependent because he is a dependent of his parents. 10. Choice “d” is correct. The child tax credit is available fully for taxpayers with AGI up to $400,000 for a joint return. The eligible children must be under the age of 17. The two Koz children qualify for the child tax credit of $2,000 each ($4,000 total). Choices “a,” “b,” and “c” are incorrect. See explanation above. 11. Choice “b” is correct. The Tillers’ child tax credit is $4,000 ($2,000 × 2 children). The refundable portion of the child tax credit is the lesser of earned income less $2,500 multiplied by 15% or $1,700 per qualifying child; as a result, the refundable portion is $3,400 ($1,700 × 2). Choices “a,” “c,” and “d” are incorrect. See explanation above. 12. Choice “a” is correct. In 2024, Camille’s unearned income in excess of $2,600 is taxed her parents’ marginal tax rate. The net unearned income of a dependent child under age 18 (or a child aged 18 to 23 who is a full-time student and does not provide over half of his/her own support) is taxed at the parent’s marginal tax rate. In 2024, net unearned income is gross unearned income reduced by $2,600, which is the dependent child’s minimum allowable standard deduction of $1,300 plus an additional $1,300 that is taxed at the dependent child’s marginal tax rate. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 3: Tax Formula and Tax Determination

Choice “b” is incorrect. The amount of Camille’s income that is taxed at her parents’ marginal tax rate is her unearned income in excess of $2,600. The $1,300 amount is the minimum allowable standard deduction amount, which is not taxed at all, or the amount of Camille’s taxable income, which is taxed at Camille’s marginal tax rate. Choice “c” is incorrect. The amount of Camille’s income that is taxed at her parents’ marginal tax rate is her unearned income in excess of $2,600. The first $1,300 of Camille’s income is not taxed at all because of the $1,300 standard deduction amount, and the next $1,300 is taxed at Camille’s marginal tax rate. Choice “d” is incorrect. Only the amount of Camille’s unearned income in excess of $2,600 is taxed at her parents’ marginal tax rate, not the entire gross unearned income of $3,600.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

Solution and Answer Guide

YOUNG, PERSELLIN, NELLEN, MALONEY, CUCCIA, LASSAR, CRIPE, SWFT COMPREHENSIVE VOLUME 2025, 9780357988817; CHAPTER 4: GROSS INCOME: CONCEPTS AND INCLUSIONS

TABLE OF CONTENTS Discussion Questions...........................................................................................................1 Computational Exercises ................................................................................................... 4 Problems ............................................................................................................................. 9 Tax Return Problems .........................................................................................................21 Research Problems ........................................................................................................... 24 Check Figures.................................................................................................................... 26 Solutions To Ethics & Equity Features ............................................................................ 28 Solutions To Becker CPA Review Questions ................................................................... 29

DISCUSSION QUESTIONS 1.

(LO 1) According to the Supreme Court in Thor Power Tool Co. v. Comm., “the primary goal of financial accounting is to provide useful information to management, shareholders, creditors, and others properly interested; the major goal of the accountant is to protect these parties from being misled. The primary goal of the tax system, in contrast, is the equitable collection of revenue.” Given they have different purposes, it would not be good policy to use financial accounting principles to measure taxable income.

2. (LO 1) The economist’s concept of income focuses on changes in the values of assets owned, whereas, under tax accounting, realization is required before income is recognized. Generally, realization occurs when there is an exchange of goods and services whose value is capable of objective measurement. 3. (LO 1) Allen received something of value from the casino. Under the broad concept of income, the airfare and hotel accommodations would be considered income. However, Allen could argue that the income should be matched with his $25,000 in gambling losses on the trip and, when the income and losses are combined, the net effect is an economic loss. As will be discussed later in the text, the net loss is not deductible, but at least the gambling losses can be used to offset the income from his gambling activities. 4. (LO 1, 4) Hana must recognize $1,800 of income from the unemployment benefits. Her savings from painting her house are not included in gross income—it was not income realized because the savings were not an amount received from another.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

5. (LO 1) Because Howard does not know how much he will receive from the sale of automobile parts and it is impractical to determine the cost of individual automobile parts, he could reason that all sales proceeds are a recovery of capital until he receives his cost of $400 and all subsequent proceeds are included in gross income. The IRS may argue that Howard should allocate his cost of the car among the various parts, which may be impractical. 6. (LO 2) The check is a cash equivalent. The employer, as principal, must recognize the income when his agent, the employee, collected it in 2024. 7. (LO 2) According to the constructive receipt doctrine, a cash basis taxpayer recognizes income at the time it is set aside or made available. The constructive receipt doctrine prevents cash basis taxpayers from deferring their income by intentionally avoiding the receipt of the income in the current tax year. 8. (LO 2) The tax on income from the Series EE bond is deferred until maturity (in three years), but the interest on the bank account is taxed each year under the OID rules. The Series EE savings bonds are exempt from the OID rules, and no interest is included in gross income until the EE bonds’ maturity date in three years. Therefore, with the Series EE bonds, the taxpayer is earning interest on his deferred taxes. 9. (LO 2) The taxpayer can defer recognizing the income in gross income by using the cash method of accounting because customers or clients pay subsequent to the taxpayer performing the services (i.e., defer recognizing income until the receivables are converted to cash). 10. (LO 3, 6) a. If Wade sold the car and gave the proceeds to his daughter, Wade would be taxed on the gain. However, if he gave the property to his daughter, she would own the source of the gain (the “tree”); therefore, she would be taxed on any gain. Assuming Wade faces a higher tax rate than does his daughter, the family would reduce its overall tax liability if Wade were to give the car to his daughter before it is sold. b. Undoubtedly, the IRS would argue that, in substance, Wade sold the car, and the transfer was a mere assignment of income to his daughter. Therefore, Wade should be taxed on the gain. However, if the daughter were not bound to sell the automobile when it was transferred to her, she and Wade could argue that the transfer of the auto was not a mere assignment of income and the sale should be taxable to the daughter. 11. (LO 3) Anita is not correct in her analysis. Anita has done nothing to establish that she has entered into a partnership with the attorney (e.g., entered into a partnership agreement nor contributed any labor or capital to a partnership). The income belongs entirely to Anita as she was the injured party and the reason for the settlement proceeds. Therefore, her gross income is the full amount of the settlement of $480,000 (see Commissioner v. Banks, 2005 USTC ¶50,155, 95 AFTR2d 2005–659, 125 S.Ct. 826). Anita is entitled to a deduction for $160,000 [§ 62(a)(20)]. 12. (LO 3) Rex must include in his gross income his share of the partnership’s income, regardless of whether his share of the profits is actually distributed to him. Therefore, Rex must recognize as gross income from the partnership $120,000 ($400,000 × 30%)

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

in 2024 and $180,000 ($600,000 × 30%) in 2025. The withdrawal of $200,000 merely reduces Rex’s basis for his partnership interest. 13. (LO 4) Whether the payments will be treated as alimony are not obvious based on the facts provided. Possible reasons why the payments will not be alimony include (1) the agreement specified that the payments are not alimony, or (2) the payments would continue to the spouse’s estate if he or she died within the 10 years, or (3) the payor and payee are members of the same household. 14. (LO 4, 6) The following issues are suggested from the facts presented: •

The transfer of any property between the spouses will be tax-free. The basis of the property to the spouse who retains it will remain unchanged.

•

The sale of any assets either before or after the divorce, will result in the same amount of gain or loss recognition. However, the couple should examine the tax rates William and Abigail currently face to those that either will face individually after the divorce.

•

Any payments made by Abigail to William for April will have no tax consequences for either party.

•

Whether considered part of the property settlement or alimony, payments made by William to Abigail subsequent to the divorce to compensate for her support of William while in medical school will not have any tax consequences.

•

April will likely be considered the dependent of William after the divorce as he will be the custodial parent.

15. (LO 4, 6) Patrick and Eva should consider the tax implications of the agreement. The property can be transferred without recognition of gain by Patrick or Eva. However, Eva’s cost basis in the stock will be the same as Patrick’s. If his basis is less than the fair market value of the stock, Eva will recognize gain when the stock is sold, assuming that the stock maintains its value. Alternatively, the cash payments, as presently structured, will not trigger any income tax. Because the payments are made pursuant to a divorce after 2018, none of the cash payments made by Patrick to Eva are taxable or deductible, despite their classification as alimony or child support. 16. (LO 4) Interest must be imputed on the loan made by Madero Corporation to Francisco Madero regardless of how the loan is classified. If the loan is characterized as being made to an employee (i.e., a compensation-related loan), the corporation must recognize imputed interest income, but the corporation will also be allowed to deduct imputed compensation for the same amount as the imputed income. Thus, the loan will have no net effect on the corporation’s taxable income (but will affect payroll taxes). Francisco’s deduction (if any) for the imputed interest paid is dependent upon how he used the borrowed funds. This is true whether the loan is characterized as an employee loan or a shareholder loan. For example, if the funds were used to buy a personal residence, the interest might be deductible as an itemized deduction. If the funds were invested, the interest might be deductible as investment interest. But if the funds were used for vacations or other personal expenditures, the

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

interest would not be deductible by Francisco. Regardless, Francisco will owe tax on the imputed interest at his regular marginal tax rate. On the other hand, while imputed interest income on a loan to a shareholder (i.e., a corporation-shareholder loan) will also result in taxable interest income for the corporation, the deemed retransfer will be treated as a nondeductible dividend paid to the shareholder. Therefore, the corporation’s income will increase by the amount of the imputed interest. However, Francisco will owe tax on it at the reduced capital gains rate. 17. (LO 4) When Connor began receiving payments, he had a life expectancy of 20 years (see Exhibit 4.1), but he collected on the annuity for approximately 17 years (2007– 2024). Therefore, he did not recover all of his capital. The unrecovered capital can be deducted as a loss in Connor’s final tax return. 18. (LO 4) Under the formula for computing taxable Social Security benefits, an increase in other income increases modified adjusted gross income, which can cause an increase in the taxable benefits. Winning the $5,000 prize may increase Carlos’s AGI by as much as $9,250 [$5,000 + 0.85($5,000)]. 19. (LO 4) a. Sonja must file an FBAR form for 2024 because, on at least one day during 2024, she had over $10,000 in a foreign bank account. b. Sonja must report the interest income earned from this account on her 2024 income tax form (Form 1040). Generally, taxpayers are required to include all income in their gross income regardless of where it is earned. 20. (LO 5) Gain on the sale of the stock is a short-term capital gain and is taxed at ordinary income rates. The gain on the sale of the land and houseboat should be combined. As long-term capital gain, the total is subject to tax at preferential rates— 20%, 15%, or 0%. The loss on the sale of the reconditioned motorcycle is personal and, therefore, nondeductible. 21. (LO 5) The short-term capital loss from the sale of the stock is offset against the long-term capital gain from the sale of the land. The net of the two qualifies as a net long-term capital gain and is taxed at the preferential capital gains rate (0%, 15%, or 20% depending on the taxpayer’s taxable income and filing status).

COMPUTATIONAL EXERCISES 22. (LO 2) The difference between the cost of the certificate and the amount due at maturity is actually interest but is referred to as original issue discount. In such an arrangement, the Code requires the original issue discount to be reported when it is earned, regardless of the taxpayer’s accounting method. The interest “earned” is calculated by the effective interest rate method. The original issue discount rules do not apply to U.S. savings bonds or to obligations with a maturity date of one year or less from the date of issue. Kunto’s total gross income from the certificate is $3,772 ($50,000 − $46,228). Kunto’s income earned each year is calculated as follows: © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

a. 2024: $46,228 × 4% = $1,849.12, rounded to $1,849. b. 2025: [($46,228 + $1,849) × 4%] = $1,923.08, rounded to $1,923. 23. (LO 2) Taxpayers generally must recognize advance payments as income in the year they are received. Code § 451(c) permits an accrual basis taxpayer to adopt an accounting method to recognize in the year of receipt only what is reported in their financial statement. The remaining amount must be recognized in the year following receipt regardless of when it will be earned. The election to defer does not apply to prepaid rent or prepaid interest. Advance payments for these items are always taxed in the year of receipt. Length of Contract

2024 Income

2025 Income

12 months

a. $14,000 × 6/12 = $7,000

c. $14,000 × 6/12 = $7,000

24 months

b. $24,000 × 6/24 = $6,000

d. $24,000 × 18/24 = $18,000

Note that, for the 24-month contracts, Bigham will only report $12,000 in its 2025 financial statements. The remaining $6,000 is reported in Bigham’s 2026 financial statements. Code § 451(c) does not allow for deferral beyond the year subsequent to the year the advance payment was received. 24. (LO 3) Under a community property system, all property is deemed either to be separately owned by the spouse or to belong to the marital community. Property may be held separately by a spouse if it was acquired before marriage or received by gift or inheritance following marriage. Otherwise, any property is deemed to be community property. For Federal tax purposes, each spouse is taxed on one-half of the income from property belonging to the community. The laws of Texas, Louisiana, Wisconsin, and Idaho distinguish between separate property and the income it produces. In these states, the income from separate property belongs to the community. Accordingly, for Federal income tax purposes, each spouse is taxed on one-half of the income. In the remaining community property states, separate property produces separate income that the owner-spouse must report on his or her Federal income tax return. In all community property states, income from personal services (e.g., salaries, wages, and income from a professional partnership) is generally treated as if onehalf is earned by each spouse. Idaho (Community Property State)

South Carolina (Common Law State)

Dividends

600

Interest

450

$900

Salary

$40,000

Note that the stock is a community asset because it was created with community funds (i.e., Simba’s salary). 25. (LO 4) For pre-2019 divorces, alimony and separate maintenance payments are deductible by the party making the payments and are includible in the gross income of the party receiving the payments. Thus, income is shifted from the income earner to the income beneficiary, who is better able to pay the tax on the amount received. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

A transfer of property other than cash to a former spouse under a divorce decree or agreement is not a taxable event. The transferor is not entitled to a deduction and does not recognize gain or loss on the transfer. The transferee does not recognize income and has a cost basis equal to the transferor’s basis. Casper is not required to recognize any gain on the transfer of the stock to Cecile. Further, although he cannot deduct anything related to the transfer of the stock, he may deduct the $7,500 of alimony payments. Cecile does not include the receipt of the stock in her gross income. She must, however, recognize a capital gain of $15,000 ($40,000 sales price − $25,000 adjusted basis) when the stock is sold. Cecile also will include the $7,500 of alimony received in her gross income. 26. ( L O 4 ) Generally, if a loan does not carry an interest rate equal to at least the applicable Federal rate, the difference between the interest charged and the Federal rate must be imputed. No interest is imputed on total outstanding gift loans of $10,000 or less between individuals unless the loan proceeds are used to purchase income-producing property. This exemption eliminates immaterial amounts that do not result in apparent shifts of income. However, if the proceeds of such a loan are used to purchase incomeproducing property, this exception does not apply. On gift loans of $100,000 or less between individuals, the imputed interest cannot exceed the borrower’s net investment income for the year (gross income from all investments less the related expenses). Thus, the income imputed to the lender is limited to the borrower’s net investment income. In addition, if the borrower’s net investment income for the year does not exceed $1,000, no interest is imputed on the loan. However, these limitations do not apply if a principal purpose of a loan is tax avoidance. As with gift loans, there is a $10,000 exemption for compensation-related loans and corporation-shareholder loans. However, the $10,000 exception does not apply if tax avoidance is one of the principal purposes of a loan. This vague tax avoidance standard makes practically all compensation-related and corporation-shareholder loans suspect. Nevertheless, the $10,000 exception should apply when an employee’s borrowing was necessitated by personal needs (e.g., to meet unexpected expenses) rather than tax considerations. a. In this example, Elizabeth’s loan to Richard is not subject to the imputed interest rules because the $10,000 gift loan exception applies. b. The $10,000 exception does not apply to the loan to Woody because the proceeds were used to purchase income-producing assets. However, under the $100,000 exception, the imputed interest is limited to Woody’s investment income ($600). However, because Woody’s net investment income is below $1,000, no interest is imputed. c. None of the exceptions apply to the loan to Irene because the loan was for more than $100,000. Therefore, Elizabeth must recognize $2,625 as interest income. $105,000 × 5% × 6/12 = $2,625.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

27. (LO 4) The tax accounting problem associated with receiving payments under an annuity contract is one of apportioning the amounts received between recovery of capital and income. The annuitant can exclude from income (as a recovery of capital) the proportion of each payment that the investment in the contract bears to the expected return under the contract. The exclusion amount is calculated as follows: (Investment/Expected Return)Annuity Payment = Exclusion. The expected return is the annual amount to be paid to the annuitant multiplied by the number of years the payments will be received. The payment period may be fixed (a term certain) or may be for the life of one or more individuals. When payments are for life, the taxpayer generally must use the annuity table published by the IRS to determine the expected return. The return of capital is calculated by multiplying the appropriate multiple (life expectancy) by the annual payment. The exclusion ratio (investment expected/return) applies until the annuitant has recovered their investment in the contract. Once the investment is recovered, the entire amount of subsequent payments is taxable. If the annuitant dies before recovering the investment, the unrecovered cost (adjusted basis) is deductible in the year the payments cease (usually the year of death). The taxpayer’s expected return is $300 × 12 × 20.8 = $74,880. The exclusion percentage is 0.667735, rounded to 66.77% ($50,000 investment ÷ $74,880). The annual tax-free recovery of capital is $2,403.72 (66.77% × $3,600 annual payment) with the remaining $1,196.28, rounded to $1,196 ($3,600 − $2,403.72), included in gross income. 28. (LO 4) a. Their includible Social Security benefits will be $10,540, the lesser of the following: 1.

85% × $12,400 Social Security benefits = $10,540.

2. Sum of: a. 85% × [$46,000 + 1/2($12,400) − $44,000 higher threshold amount] = $6,970 and b. Lesser of: 1.

Amount calculated using the lower threshold amount, which is the lesser of: •

50% × $12,400 Social Security benefits = $6,200.

•

50% × [$46,000 + 1/2($12,400) − $32,000] = $10,100.

2. $6,000. The sum equals $12,970 ($6,970 + $6,000). Because 85% of the Social Security benefits received is less than this amount, only $10,540 is included in the couple’s gross income. b. The taxpayers must include $0 of the benefits in gross income. This is determined as the lesser of the following: 1.

50% × $16,000 Social Security benefits = $8,000.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

2. 50% × [$12,000 + 1/2($16,000) − $32,000] = 50% × −$12,000 = −$6,000. None of the benefits would be taxable because the result is not a positive number. c. Their includible Social Security benefits will be $12,750, the lesser of the following: 1.

85% × $15,000 Social Security benefits = $12,750.

2. Sum of: a. 85% × [$85,000 + 1/2($15,000) − $44,000 higher threshold amount] = $41,225 and b. Lesser of: 1.

Amount calculated using the lower threshold amount, which is the lesser of: •

50% × $15,000 Social Security benefits = $7,500.

•

50% × [$85,000 + 1/2($15,000) − $32,000] = $30,250.

2. $6,000. The sum equals $47,225 ($41,225 + $6,000). Because 85% of the Social Security benefits received is less than this amount, only $12,750 is included in the couple’s gross income. 29. (LO 5) The sale of the scooter results in a realized loss of $150 ($700 − $550). However, losses realized from the sale of personal use property (property neither held for investment nor used in a trade or business) are not recognized. The sale of the stock results in a realized gain of $300 ($1,200 − $900). The gain must be recognized but will be taxed at the preferential capital gains rates (0%, 15%, or 20% depending on the taxpayer’s taxable income and filing status). 30. (LO 5) Individual taxpayers combine capital gains and losses in a specific netting process. To arrive at a net capital gain, capital losses must be taken into account. The capital losses are aggregated by holding period (short-term and long-term) and applied against the gains in that category. If excess losses result, they are then shifted to the category carrying the highest tax rate. A net capital gain will occur if the net long-term capital gain (NLTCG) exceeds the net short-term capital loss (NSTCL). For individual taxpayers, net capital loss can be used to offset ordinary income of up to $3,000 ($1,500 for married persons filing separate returns). If a taxpayer has both short- and long-term capital losses, the short-term category is used first to arrive at the $3,000. Any remaining net capital loss is carried over indefinitely until exhausted. When carried over, the excess capital loss retains its classification as short- or long-term.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

Tamara has a net long-term capital gain of $1,000 ($2,000 + $500 − $1,500) and a short-term capital loss of $4,100. When netted, the result is an overall net short-term capital loss of $3,100. As a result, Tamara is allowed a $3,000 deduction in the current year and has a $100 short-term capital loss carryover to the following year.

PROBLEMS 31. (LO 1) a. The $500,000 is economic income and gross income for tax purposes. Ja-ron realized $500,000 for agreeing not to compete and must include the entire amount in gross income. Pay for not performing is treated the same as pay for performing. b. The $5,000 is economic income and gross income for tax purposes. c. The $100,000 is an increase in wealth and economic income. It is also realized and must be included in Valery’s gross income. d. Winn’s economic income is $749,995 (the winnings less the cost of the ticket). The answer is the same for tax purposes under the recovery of capital doctrine (receipts less the basis in the investment). e. Larry has economic income of $1,400 from the production in his garden. However, the income has not been realized and is, therefore, not taxable. The realization requirement is not satisfied because the vegetables are consumed by Larry and his family rather than sold to others. f.

Dawn has economic income of $2,000. Dawn did not realize gross income at the time of the bargain purchase. She will have realized gain when (and if) she sells the automobile for more than $1,500, her cost.

32. (LO 1, 2, 6) The taxable bond and reinvested earnings will accumulate at an after-tax rate of 4.0% [(1 − 0.24) × 0.05333] to equal $12,167 at the end of five years [($10,000 × 1.2167) = $12,167]. The income from the Series EE bond will not be taxed until maturity in five years, and the after-tax value will be $11,672 [$12,200 − 0.24($12,200 − $10,000)]. Thus, the after-tax proceeds from the land must exceed $12,167. Because the gain on the land will be taxed as a long-term capital gain, the sales proceeds less 15% of the appreciation must exceed $12,167. $10,000 + (1 − 0.15)(X − $10,000) = $12,167 $10,000 + 0.85X − $8,500 = $12,167 0.85X = $10,667 X = $12,549

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

Thus, the land must increase in value by more than $2,549 to yield a greater after-tax return than the investment in either of the bonds. A 7 8 9 10 11 12 13 14 15 16 17 18 19 20

EE Bond

Corporate Bond Investment amount Number of years Annual pretax yield

10,000 5 0.0533

Land

Investment amount

10,000

Investment amount

10,000

Pre-tax future value

12,200

Pre-tax future value

= (H20-H9)/ (1-H15)+H9

Annual pretax return

= (B9*B11)

Tax rate

0.24

Tax rate

0.24

Tax rate

0.15

After-tax yield

= (B13* (1-B15))/(B9)

Taxes

= (E11-E9)*E15

Taxes

= (H11-H9)*0.15

After-tax future value

= (B9)* (1+B17)^5

After-tax future value

= (E11-E17)

After-tax future value

12,167

33. (LO 1) a. The $1,500 is a reduction in the cost of the automobile and is not income. b. The $50,000 payment received under the covenant is included in Amos’s gross income because the payment is an increase in wealth realized. c. The change in the zoning rules that causes the property to increase in value is economic gain but is not a realized gain for tax purposes. Amos’s wealth increased, but the realization requirement is not satisfied because he did not receive any additional property, nor were any improvements made to his property. Amos will not realize this increase in wealth for tax purposes until he sells the property.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

34. (LO 1, 2) a. Of the value of the corporate stock Deb received, $300 was for her accrued interest. The remaining $11,700 was in exchange for the bond whose cost was $10,000. Deb should have recognized $300 interest income and $1,700 gain ($11,700 − $10,000) when she exchanged the bond for stock. The fact that the stock decreased in value after the exchange is not relevant because she still owns the stock and thus has not realized the loss in value. b. Deb did not realize income when she borrowed on the property. Her net worth did not increase—assets and liabilities increased by an equal amount. c. Deb must recognize compensation income of $600 ($300 × 2), the fair market value of the tickets at the time she received them. d. Deb must report a capital gain of $350 from the sale of her yearbook. If she had sold it for less than the $50 basis, the loss would not be allowed because this is a personal use asset. This gain is taxable even if Deb receives no information report about the sale, such as a Form 1099–K. 35. (LO 2, 6) a. Al’s gross income for 2024 on the cash basis is $292,000 ($280,000 + $12,000), which is the amount he actually collected in that year. b. Al’s gross income computed by the accrual method is as follows: Cash received Less: Income received but will not be earned until 2025 Less: Beginning-of-the-year accounts receivable Plus: End-of-year accounts receivable Gross income

$292,000 (12,000) (40,000) 60,000 $300,000

c. Al should consider using the cash method of accounting so that he will not have to pay income taxes on uncollected accounts receivable. The tax law does not require Al to use the accrual method. 36. (LO 2) a. Accrual basis gross revenues: Cash received Less: Beginning accounts receivable Less: Bank loan Add: Ending accounts receivable Gross revenue

$1,400,000 (200,000) (100,000) 250,000 $1 ,350,000

b. Gross income: Gross revenue Cost of goods sold: Purchases Beginning inventory Ending inventory Gross income

$1,350,000 $1,300,000 150,000 (300,000)

(1,150,000) $ 200,000

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

37. (LO 2) TO:

Susan Apple

FROM:

Bill Swan

SUBJECT:

Dispute over Recording of Income by Trip Garage, Inc.

DATE:

May 1, 2025

I am responding to the questions you raised regarding the timing of the reporting of income by Trip Garage, Inc., for repairing Samuel Mosley’s car. The key issue is whether the garage should (1) accrue the $1,000 of income in 2024 and take a $100 loss deduction in 2025 (the IRS view) or (2) report the $900 in 2025 (Trip’s preferred approach). An accrual basis taxpayer is required to recognize income when (1) all the events have occurred to establish the taxpayer’s right to receive the income, and (2) the amount of the income can be determined with reasonable accuracy. In Trip’s case, it does not appear that all the events to fix the rights to the income had occurred in 2024. The customer did not accept the work by the end of the year. Thus, the transaction should be held open in 2024, and no income and related costs should be reported until 2025. 38. (LO 2) a. The check is a cash equivalent; therefore, the $1,500 must be included in the cash basis taxpayer’s 2024 gross income when it was actually received. b. The check is not a cash equivalent because of the restrictive conditions placed upon it. Therefore, a cash basis taxpayer does not include the $1,500 in gross income until 2025. c. The fact that the bank was closed is not relevant. The check is a cash equivalent; therefore, the $1,500 must be included in 2024 gross income. 39. (LO 2, 4) a. The Series EE bonds are not subject to the original issue discount (OID) rules. Therefore, assuming that Marlene did not elect to take the annual increments in value into income each year, her 2024 gross income from the bonds is $2,910 ($10,000 − $7,090). b. The CD contains $816 ($10,816 − $10,000) of original issue discount (OID), which must be amortized by the effective interest method. Because Marlene owned the CD for six months in 2023, she should have recognized $200 ($10,000 × 0.04 × 1/2 year) in 2023. In 2024, Marlene earned 4% on the compounded amount of the investment, and her 2024 gross income from the bonds is $408 [0.04($10,000 + $200)]. c. The CD’s maturity date is not more than one year from its date of issue; therefore, the OID rules do not apply. Marlene, as a cash basis taxpayer, is not required to recognize any income ($300) until 2025, when the CD matures.

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Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

40. (LO 2) a. The $1,200 is included in the 2024 gross income. The advance payment received in 2023 for goods delivered in 2024 may be deferred based on Drake’s method of accounting. b. For the sale of the six-month service contract, $120 is included in 2024 gross income ($240 × 3/6 = $120). The advance payment for services qualifies for proration over the life of the contract. With respect to the 36-month contract, Drake must include in 2024 gross income $210 ($1,260 × 6/36). Drake would include in 2025 gross income $1,050 ($1,260 − $210), the balance on the contract sold in 2024 for services that would not all be performed by the end of the tax year of receipt. That is, the portion of the advance payment that relates to services to be performed after the tax year of receipt is included in gross income in the tax year following the tax year of receipt of the advance payment. c. The company must include $450 in gross income ($1,200 sale less $750 recovery of capital for the cost of the appliance). The fair market value of the note is not relevant for purposes of determining the accrual method taxpayer’s gross income. The interest of $240 will be taxed as it accrues over the 24-month life of the contract. 41. (LO 2) Gross income is not recognized by an accrual basis taxpayer until all of the events that fix the taxpayer’s right to the income have occurred. For taxpayers who issue applicable financial statements, the all events test generally is met no later than the time income is included in those financial statements (the AFS inclusion rule). However, the AFS inclusion rule does not require recognition if the taxpayer does not have an enforceable right to the income at the end of the year. a. In this case, the taxpayer is required to deliver 100 customized computers. Since only 75 have been delivered at the end of 2024, the all events test would require that no income be included in Wright’s gross income. The AFS inclusion rule would not be applicable since it does not appear as though Wright’s has an enforceable right to the income at the end of the year. b. In this case, Wright’s appears to have an enforceable right to the $22,500 included in its financial statements, even if the customer exercises its option to cancel the contract before delivery of the final 25 computers. Therefore, Wright must recognize the $22,500 in its gross income under the AFS inclusion rule. 42. (LO 2, 6) a. No. The amount the employer might have been willing to pay is not constructively received in 2025 because Freda did not have a right to the income before she agreed to be paid in 2025. The constructive receipt doctrine cannot change actual events to “what might have been done.”

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

b. Freda may have expected to be in a lower marginal tax bracket in 2026. She also benefited by not having to pay the tax on the income shifted into 2026 until she filed her 2026 income tax return in 2027 or made payments on estimated taxes for 2026. 43. (LO 2, 6) a. •

The $1,000 damage deposit is not taxed in the year of receipt.

•

The damage deposit is not taxable at the time it is collected, but the $500 prepaid rent is taxed in the year of receipt.

•

The $1,000 prepaid rent is taxed in the year of receipt.

b. The Bluejay Apartments should use the first option. Note that in either case, they will receive $1,000 at the signing of the lease and $1,000 less at the end of the lease term (because the rent was prepaid and/or because the deposit must be returned). By collecting the $1,000 damage deposit, tax is deferred without affecting the pretax cash flows. 44. (LO 1, 2, 3) Salary Interest Loss Salary Gross income

$100,000 6,000 –0– 20,000 $126,000

Rusty earned $100,000 and used $20,000 to pay his debts. Rusty must include his gross income from all geographic sources. The corporation is the owner of the property; therefore, the rent income and expenses are those of the corporation. Rusty received the salary from the corporation, a separate entity.

Rusty is not taxed on the $5,000 interest and dividends received by Rebecca because she is the owner of the income-producing property. 45. (LO 2) a. The cash basis corporation must recognize the income of $10,000 in 2024, when its agent, Troy, received the check, a cash equivalent. Troy will not recognize any bonus until it is actually or constructively received. The fact that the employer received the fees in 2025 does not affect the time Troy recognizes the bonus. b. The corporation must recognize the income in 2024, when the agent, Troy, performed the services. Troy will recognize the 10% bonus in 2025 because neither actual nor constructive receipt of the bonus occurs in 2024. c. The fact that the customer admits that the check will not be honored if presented at the end of the year means that the check is not a “cash equivalent.” Furthermore, the restriction on when the check can be presented for payment is “substantial.” Thus, income is not recognized in 2024.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

46. (LO 3) Each partner’s share of the partnership income is one-third of the taxable income earned by the partnership. Therefore, each partner’s gross income is $90,000 [($270,000) ÷ 3]. The contributions and distributions in this case do not affect any of the partners’ gross income. They merely increase or decrease the partner’s investment in the partnership. 47. (LO 3, 6) a. Amur dividends (Note 1) Blaze dividends (Note 2) Grape dividends Total dividend income

$ 60,000 40,000 22,000 $122,000

Note 1:

Even though Amur is a foreign corporation, the dividend is a qualified dividend because its stock is traded on an established U.S. securities market.

Note 2:

The dividend paid by Blaze is not a qualified dividend because the holding period requirement is not satisfied (i.e., must be held more than 60 days during the 121-day period beginning 60 days before the ex-dividend date).

Qualified dividends Amur dividend Grape dividend Applicable rate Tax on qualified dividends

$60,000 22,000 $82,000 × 15% $ 12,300

Non-qualifying dividends Blaze dividend Applicable rate Tax on non-qualified dividends

$40,000 × 32% $12 , 800

Total tax on dividends

$25 , 100

b. The daughter is in the 10% marginal tax bracket. She has $1,000 of qualified dividends that are eligible for the alternative tax rate of 0% (rather than the usual 15%). So the daughter’s tax liability on the dividends is $0 ($1,000 × 0%). c. Alva’s after-tax return on the bond is 3.06% [(1 − 0.32)(0.045)]. Her after-tax return on the stock is 3.4% [(1 − 0.15)(0.04)]. Therefore, the stock yields the greater after-tax return because any appreciation in value is the same. d. The daughter is in the 10% marginal tax bracket. Therefore, her after-tax return on the bond is 4.05% [(1 − 0.10)(0.045)]. Her after-tax return on the stock is 4.0% [(1 − 0.00)(0.04)]. Therefore, the bond yields the greater after-tax return.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

48. (LO 3, 6)

Salary Rent Dividends Interest

a. California Doug Imani $48,000 $48,000 8,000 1,900 1,200 1,200 $51,100 $57,200

b. Doug $48,000 4,000 950 1,200 $54,150

Texas

Imani $48,000 4,000 950 1,200 $54,150

Under Texas law, the rents and dividends belong to the community even though this income is derived from separate property. Under California law, the income is community or separate depending on the state law classification of the underlying assets. In this case, the interest is community income because the savings account was funded with community property. 49. (LO 4) a. The transfers of the stock and residence pursuant to the divorce are nontaxable to Nell and Kirby. Nell assumes Kirby’s basis in the stock of $150,000, and Kirby’s basis in the house is $300,000. The $50,000 cash paid by Kirby will be alimony unless the agreement specifies that the payment is “not alimony.” However, because the divorce agreement is finalized after 2018, the $50,000 will have no impact on the taxable income of Kirby or Nell. b. Given the payments will continue to be made to Nell’s estate should she die, they appear to be part of a property settlement and not alimony. Regardless of their classification as alimony or property settlement, the payments are neither included in Nell’s gross income nor deductible by Kirby since they are pursuant to a divorce agreement reached after 2018. c. The monthly payments of $1,200 are in part child support and in part alimony. The monthly amount that will continue after the occurrence of the contingency related to the child is considered alimony. Therefore, $300 per month is considered alimony, and the other $900 received each month is child support. However, regardless of their classification as alimony or child support, they are neither deductible by Kirby nor included in Nell’s gross income. d. Even if the divorce were settled in 2017, the cash payments of $1,000 per month do not qualify as alimony because they will not cease upon Nell’s death. Therefore, the payments would still be excluded from Nell’s gross income and not deductible by Kirby. 50. (LO 4) Under these facts, it would seem that a fair division would mean that each spouse received equal value as calculated on an after-tax basis. Under the proposal, each spouse will receive equal value as calculated on a before-tax basis, but Rafel will receive less than Alicia after taxes are considered. Under the plan, Rafel and Alicia will receive an equal before-tax amount of $280,000. Rafel will receive assets with a fair market value of $410,000 but will incur a $130,000 liability to Alicia. Since Rafel pays Alicia the $17,600 each year, the payments will not be deductible by Rafel as alimony (or included in Alicia’s gross income). Moreover, the interest on the obligation will not be deductible because it is not incurred in a trade or business or a transaction entered into for profit. Therefore, the after-tax interest rate

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

on the loan is the same as the stated rate of 6%. The other property transactions will have substantial tax implications. Rafel’s basis in the investment assets will be $160,000. Therefore, if the investments were sold for their current value, Rafel would have a $250,000 ($410,000 − $160,000) taxable gain. Rafel would incur a $37,500 ($250,000 × 15%) tax liability. However, Alicia will not have any tax liability as a result of the proposed transactions because she does not intend to sell the appreciated asset she received, the personal residence. Even if she did sell the residence, the realized gain would be exempt from tax under the § 121 exclusion (see Chapter 13). 51. (LO 4, 6) The family’s after-tax cash flow will decrease by less if Roy borrows from Hal rather than the bank. Interest is imputed on the loan from Hal (at 3%) because the interest rate charged by Hal (2%) is less than the Federal rate (3%). With the loan from Hal, all of the interest stays in the family rather than being paid to and received from the bank, Hal’s tax on his interest income decreases, and Roy’s tax benefit from deducting the interest decreases by a lesser amount.

Hal’s interest on CD, $150,000 × 0.035 Less: Tax on the interest income, $5,250 × 0.32 Hal’s interest on loan to Roy, $150,000 × 0.03 = $4,500 Less: Hal’s tax on imputed interest, ($150,000 × 0.03) × 0.32 Roy’s bank interest expense, $150,000 × 0.04 Roy’s tax benefit from deducting interest, $6,000 × 0.12 Roy’s tax benefit from interest to Hal, ($150,000 × 0.03) × 0.12 After-tax cash flow to family

Borrow from Bank $ 5,250 (1,680) (6,000) 720 ($ 1,710)

Borrow from Hal

($1,440)

540 ($ 900)

52. (LO 4) a. The imputed interest rules do not apply because the loan was less than $100,000, and Jim does not have any investment income. The imputed interest amount for six months is $180 ($12,000 × 0.03 × 0.5). However, Aldridge will include nothing in his gross income. b. The imputed interest rules do not apply because this gift loan was for less than $10,000, and it was not used to purchase income-producing property. Aldridge will include nothing in his gross income. c. The imputed interest for four months is $250 ($25,000 × 0.03 × 4/12). However, because the amount of the gift loan does not exceed $100,000, the imputed interest is limited to an amount equal to Al’s net investment income of $220. Further, because this amount does not exceed $1,000, no interest is imputed. d. The imputed amount for three months is $1,125 ($150,000 × 0.03 × 3/12). The investment income limitation does not apply to this loan because the loan exceeded $100,000. Therefore, Aldridge must include $1,125 of imputed interest in his gross income.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

53. (LO 4) a. This loan is a gift loan between individuals that is eligible for the $100,000 exception. Although Mike’s sister has $900 of investment income, interest is not imputed under this exception if the borrower’s net investment income is not greater than $1,000. So the imputed amount is $0. b. This loan is an employer-employee loan for not greater than $10,000. Since there appears to be no tax avoidance motive, no interest is imputed. c. Interest is imputed on this loan. The $100,000 exception is not available on corporation-shareholder loans. The imputed interest would be calculated as follows: $25,000 × (5% − 4%) × 1/2 = $125 d. The loan from Kait to Jake is classified as a gift loan between individuals that is eligible for the $100,000 exception. The imputed interest income for the six months is calculated as follows: $60,000 × 5% × 1/2 = $1,500 Under the $100,000 exception, the imputed interest is limited to Jake’s net investment income of $2,100. In this case, the limit has no effect on the amount of imputed interest. 54. (LO 4) a. It is unlikely this employer-employee loan would qualify for the $10,000 exception because it appears the loan is made to avoid tax on what would otherwise be taxable compensation. The $100,000 exception does not apply to these loans as it is only available for gift loans. Therefore, for 2023 and 2024, interest will be imputed as follows: 2023 ($8,000 × 4% × 6/12) 2024 ($8,160 × 4% × 6/12) ($8,160 + $163 + $10,000)(0.04)(6/12)

$160 $163 366

$529

The corporation will report imputed interest income and offsetting wage expense each year with no net impact on its taxable income. Vito will likewise report imputed compensation income and interest expense each year though the interest expense is likely not deductible. b. It is similarly unlikely that this corporation-shareholder loan would qualify for the $10,000 exemption because it appears that a principal purpose of the loan is to avoid tax on what would otherwise be a taxable dividend. Nor is it eligible for the $100,000 exception, which is only available for gift loans. Therefore, for 2024 and 2025, the corporation has interest income and dividends paid (not deductible) as computed above. Vito will recognize interest expense and dividend income. Although the interest is still likely not deductible, the income will be taxable at the preferential capital gains rate.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

55. (LO 4) Because this is a qualified retirement plan distribution, the simplified method is used to calculate the annuity exclusion amount. a. Cost (her investment) = $42,000 Employee’s investment Number of anticipated payments (Exhibit 4.2)

$42,000 210

Collections in 2023 (6 payments × $3,000) Exclusion for capital recovery ($200 × 6 payments) Include in gross income

$200 exclusion per payment

$18,000 (1,200) $16,800

b. Pam will have recovered her investment as a return of capital prior to the twentyfourth year (i.e., 17 years and 6 months). Thus, all annuity payments received in the twenty-fourth year ($36,000) are includible in her gross income. $3,000 × 12 payments = $36,000 c. Income from collections in final year: [$24,000 collected − (8 × $200 = $1,600 exclusion)]

$22,400

Investment in the contract Less: Capital recovered ($200 exclusion × 160 payments) Unrecovered cost (loss in the final year return)

$42,000 (32,000) $10,000

56. (LO 4) a. Peyton is required to include $60,000 in gross income, the value of the automobile. The award does not satisfy the right type of achievement requirement to qualify for exclusion from gross income. In addition, the exclusion requires the recipient to contribute the award to a qualified governmental unit or nonprofit organization. b. The Nobel Prize is awarded in recognition of a qualified achievement, it is awarded with no action on the part of the recipient, and Jacob is not required to render any future services as a condition of receiving the award. Jacob, therefore, can exclude from his gross income the $1,400,000 Nobel Peace Prize received and then given to the United Nations, assuming that the United Nations is a qualified nonprofit organization. c. The $10,000 Linda received cannot be excluded because it was not received in recognition of a qualifying achievement (e.g., scientific, artistic). The entire $10,000 of cash and prizes she received is taxable.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

57. (LO 2, 3, 4) Salary Unemployment compensation Interest income Dividend income Lottery winnings Gross income

$ 90,000 8,800 60 550 1,495* $100,905

*The $5 cost of the lottery ticket is a return of capital making Herbert’s gross income from this winning ticket $1,495. Note: Neither the $12,000 loan nor the principal of $1,940 from the savings account withdrawal is included in gross income. 58. (LO 4, 6) Without the anticipated sale, the couple’s provisional income is $32,000 ($25,000 of pension and dividend income + 1/2 ($14,000), meaning none of their Social Security benefits are taxable. The sale will increase the taxability of their Social Security benefits as follows: Pension, dividends and capital gain One-half of Social Security benefits Provisional income Threshold Inclusion base

$35,000 7,000 42,000 (32,000) 10,000 × 50% $ 5,000

As a result, the $10,000 gain on the proposed sale will make $5,000 of their Social Security benefits taxable, increasing their gross income by $15,000. Note: The increase in AGI exceeds the increase in earnings because more of the Social Security benefits became taxable. 59. (LO 3, 4, 6) Donna has substantial tax problems: a. Donna’s share of the partnership income of $150,000 will be taxable to Donna even though the income was not distributed. Therefore, she will need to come up with the cash required to pay the taxes. b. A portion of the Social Security benefits will be taxable. The fact that Donna loaned the proceeds to her nephew does not change the fact that she has a claim of right to the benefits. Further, given her partnership income from part a. her gross income likely will increase $7,140 ($8,400 × 0.85) as a result of her Social Security benefits. c. Donna must report the $1,200 of interest income even though the creditor received the money. She owned the property that earned the income. Also, she benefited from the income in that the money was used to satisfy her liability. d. Donna will be required to include in gross income one-half of her husband’s

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

60. (LO 5) a. Inez has the following results: LTCG (land) STCG (ADM stock) LTCG (boat and trailer) Loss on camper (nondeductible)

$6,000 2,450 1,000 –0–

Inez has a net LTCG of $7,000 and a net STCG of $2,450. Given her taxable income, Inez has a marginal tax rate of 32%. As a result, her tax on the capital gains is $1,834 [($7,000 × 15%) + ($2,450 × 32%)]. b. $294 [($7,000 × 0%) + ($2,450 × 12%)]. Inez has a net LTCG that will be taxed at 0%; her net STCG will be taxed at her marginal tax rate of 12%.

TAX RETURN PROBLEMS 61. Gross income: Salary and commissions ($74,000 + $86,000) (Note 1) Interest income on certificate of deposit Interest income on Second Bank savings account (Note 2) Dividends on CSX stock (Note 3) Prize income (Note 4) Deductions for adjusted gross income Adjusted gross income Standard deduction (greater than itemized deductions) Taxable income

$160,000 382 1,600 4,200 7,000 (–0–) $173,182 (27,700) $145,482

Tax liability (Note 5) Dependent credit (Note 6) Less: Tax withheld by employers ($12,400 + $11,000) Estimated tax payments Net tax payable (or refund due) for 2023

$ 22,327 (1,000) (23,400) (6,000) ($ 8,073)

Completed tax forms for this problem are available on the Cengage Instructor Center. Notes (1)

The $3,100 commission for Freida is not included in her gross income until it is received in 2025.

(2)

The $900 of interest on the City of Corbin bonds is excluded from gross income.

(3)

The dividends of $4,200 on the CSX stock are included in Dan and Freida’s gross income.

(4)

The game show winnings are taxable income. Therefore, Dan must include this amount in his gross income.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

(5)

The Butler’s tax liability before the dependent credit is $22,327: Tax on dividend income ($4,200 × 15%) Tax on other taxable income ($141,282) (from Tax Rate Schedule)

(6)

630 21,697 $22,327

When considering her status as a dependent of Dan and Frieda, Gina meets the requirements of a qualified child. However, she is not considered a qualified child for purposes of the child credit because she is over the age of 16. Nonetheless, as a dependent, Dan and Frieda may claim a $500 dependent credit. Willie, their son, also qualifies as a dependent as a qualifying child. While his gross income exceeds the exemption amount, there is no gross income test under the qualifying child requirements. Further, he satisfies the qualifying child age requirement by being a full-time student during five calendar months. However, because Willie is not under age 17, Dan and Frieda cannot claim the $2,000 child credit for Willie but can claim the $500 dependent credit. Ben, their son, fails to qualify as a dependent because of the age requirement for a qualifying child and because of the gross income test for a qualifying relative.

62. The client’s 2024 tax return as prepared by the staff should be adjusted as follows: Pension Interest income Dividend income Annuity income Social Security benefits Imputed interest Net rent income Gross income Deductions for AGI AGI Less: Itemized deductions / Standard deduction Taxable income Tax liability Less: Estimated tax payments Net tax payable (or refund due) for 2024

As Prepared $39,850 10,000 2,000 5,400 7,000

$(4,500)1

1,7505 $66,000 (–0–) 66,000 (20,800) $45,200 $ 5,100 (5,900) $ (790)

(2,160)2 4,9003 1,6004

5,5006 9327

Corrected $39,850 5,500 2,000 3,240 11,900 1,600 1,750 $65,840 (–0–) 65,840 (15,300) $50,540 $ 6,032 (5,900) $ 132

Notes (1)

The $4,500 of interest on the City of Alto bonds is excludible from gross income.

(2)

The exclusion percentage and the related annual exclusion on the annuity contract Cecil purchased are calculated as follows: $46,800 $450 × 260 payments

= 40% × $5,400 = $2,160

Cecil received $5,400 of annuity payments from the insurance company this year. Thus, Cecil must include $3,240 ($5,400 − $2,160) in his gross income this year.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

(3)

The amount of the Social Security benefits that Cecil must include in his gross income is the lesser of the following two amounts: a. 85%($14,000) = $11,900 b. Sum of: (1) 85%[$65,840 − $11,900 + $4,500 + 1/2($14,000) − $34,000] = $26,724 and (2) Lesser of: (a) 50%($14,000) = $7,000 50%[$65,840 − $11,900 + $4,500 + 1/2($14,000) − $25,000] = $20,220 (b) $4,500 Thus, $26,724 + $4,500 = $31,224. Because the amount calculated under part a. of $11,900 is less than the amount calculated under part b. of $31,224, the $11,900 is included in Cecil’s gross income.

(4)

Because Cecil made a below-market gift loan to Sarah, he needs to determine whether any imputed interest should be included in his gross income. The loan qualifies under the $100,000 exemption. Because Sarah’s net investment income is only $1,600, Cecil must include only $1,600 in his gross income rather than $2,400 ($60,000 × 4%).

(5)

The net rental income from the townhouse is as follows: Rent income Less: Expenses Utilities Maintenance Real estate taxes Insurance Depreciation Net rent income

(6)

$ 9,000 $2,800 1,000 750 700 2,000

(7,250) $ 1,750

Cecil’s itemized deductions are as follows: Personal property taxes State income taxes Charitable contributions

$ 3,10 0 3,800 8,400 $15 ,300

Cecil’s state income taxes paid of $3,800 exceeded the sales taxes he paid of $912. Cecil does not qualify for the head of household filing status. He maintains a home for his unmarried daughter, Sarah, but she is not his dependent. Even though she is unmarried, Sarah must be his dependent for head-of-household purposes. Thus, Cecil must use the single filing status. Cecil’s standard deduction would be $14,600 (the basic standard deduction for single taxpayers). Thus, Cecil will itemize deductions.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

(7)

Tax on $48,540 ($50,540 − $2,000) (from 2024 Tax Rate Schedules) 15% × $2,000 dividend income

$5,732 300 $6,032

RESEARCH PROBLEMS 1.

CLIENT LETTER SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 December 29, 2024 President, Tranquility Funeral Home, Inc. 400 Rock Street Memphis, TN 38152 Dear Sir: You asked me to address the question of when the income from preneed funeral contracts should be included in gross income. Based on my research, I have concluded that the amounts collected are customer deposits rather than the receipt of prepaid income. Therefore, the prepaid amounts are not included in gross income until Tranquility performs the services. In a case involving a situation much the same as yours, Perry Funeral Home, Inc., (86 TCM 713, T.C.Memo. 2003–340), the Tax Court concluded that the prepayments were refundable deposits under the control of the customer and, therefore, were not prepaid income. The payments were not prepaid income because the customer was not required to use the service—the customer could demand a refund anytime prior to the time the goods and services were provided. The Tax Court cites as authority Comm. v. Indianapolis Power & Light Co., [65 AFTR 2d 90–394, 110 S.Ct. 589, 493 U.S. 203 (1990)], which held that refundable utility deposits were not prepaid income. Please call me if you have any further questions. Sincerely, Jane J. Jones, CPA Partner

2. Your client received the proceeds and had the free and unrestricted use of the funds. As a result, she must include the $50,000 in her gross income. To balance her taxable income with her economic income, your client may be permitted a tax loss. The fraud she claims was committed against her gave rise to a claim against her father. If the father is convicted but she cannot recover from him, she may be entitled to claim a loss on her tax return. The facts of your client’s situation are similar to those found in Reinaldo Moracen, T.C. Summary Opinion 2007–69.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

3. The source of authority is Rev.Proc. 2011–17, 2011–5 I.R.B. 441, 2011. This can be found by searching the terms gift card and cash refund in the U.S. Tax Reporter— Explanations in the RIA editorial materials. It is unlikely that the IRS will change this result despite § 451(c) replacing Rev.Proc. 2004–34. We will need to see what the IRS says in its future guidance under this new provision.

RESEARCH PROBLEMS 4 TO 7 These research problems require that students utilize online resources to research and answer the questions. As a result, solutions may vary among students and courses. You should determine the skill and experience levels of the students before assigning these problems, coaching where necessary. Encourage students to use reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax professionals, academics, think tanks, and political outlets to research their answers. 4. Search on the question “Are lottery winnings taxable in California?” The Tax Foundation website (taxfoundation.org/data/all/state/vaccine-lottery-winnings-tax/) and the California State Lottery Winner’s Handbook (calottery.com/claim-a-prize) indicate that the state of California does not tax lottery winnings. However, more searching reveals that although the state does not tax California lottery winnings, winnings of other states’ lotteries are taxable by the state [see the instructions for the California Schedule CA (540)]. 5. Student responses will vary. Information related to the use of a “hard fork” or an “airdrop” can be found in Rev.Rul. 2019–24. Additional information on virtual currency (including additional class discussion questions) can be found on the IRS website (irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtualcurrency-transactions). 6. The Moore case before the U.S. Supreme Court in the 2023–2024 term is a significant case that addresses the meaning of some cases mentioned in Chapter 4 such as Eisner v. Macomber and Glenshaw Glass. Numerous amicus curiae briefs were filed in this case. At the time this text went to print, the decision was not yet known but this research question is included due to the importance of this case to clarifying the meaning of the phrase “incomes, from whatever source derived” in the Sixteenth Amendment to the Constitution. The petition and amicus briefs can be found at supremecourt.gov/search.aspx?filename=/docket/docketfiles/html/public/22800.html and the decision can be obtained from Checkpoint. 7. Student responses will vary. In general, students will find that the current versions of the AI tools often provide incomplete or incorrect answers to complex tax questions. In late 2023, ChatGPT’s response to the information in Discussion Question 18 only addressed the increase in income for the prize; it did not recognize that the increase to AGI likely makes more of the winner’s Social Security benefits taxable. Prompting the generative AI tool to specifically address the implications of the prize on the portion of Social Security benefits that are taxable (or providing a specific amount of Social Security benefits), might lead to a more complete response from the tool. The results may be different when students prompt this question to a generative AI tool in 2024 or later.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

CHECK FIGURES 22.a. 22.b. 23.a. 23.b. 23.c. 23.d. 24.a. 24.b. 24.c. 24.d. 24.e. 24.f. 25.

26.a. 26.b. 26.c. 27. 28.a. 28.b. 28.c. 29. 30. 31.a. 31.b. 31.c. 31.d. 31.e. 31.f. 32. 33.a. 33.b. 33.c. 34.a. 34.b. 34.c. 34.d. 35.a. 35.b. 35.c. 36.a. 36.b.

$1,849. $1,923. $7,000. $6,000. $7,000. $18,000. $600. $450. $40,000. $0. $900. $0. Casper recognizes no gain/loss on the stock transfer and a $7,500 deduction for AGI for the alimony payments. $0. $0. $2,625. 66.77%; $1,196. $10,540. $0. $12,750. $150 loss disallowed on scooter; $300 gain recognized on stock. Net short-term capital loss of $3,100. $500,000. $5,000. $100,000. $749,995. $0 for tax purposes. $0 for tax purposes. Land needs to increase in value by more than $2,549. Gross income $0. Gross income $50,000. Gross income $0. $300 interest income and $1,700 gain. Gross income $0. Gross income $600. Gross income $350. Cash basis income $292,000. Accrual basis income $300,000. Cash method. Gross receipts $1,350,000. Gross income $200,000.

37. 38.a. 38.b. 38.c 39.a. 39.b. 39.c. 40.a. 40.b.

40.c. 42.a. 42.b. 43.a. 43.b. 44. 45.a. 45.b. 45.c. 46. 47.a. 47.b. 47.c. 47.d. 48.a. 48.b. 49.a. 49.b. 49.c. 50. 51. 52.a. 52.b. 52.c. 52.d. 53.a. 53.b. 53.c. 53.d.

Trip should report in 2025. Include $1,500 in 2024. Include $1,500 in 2025. Include $1,500 in 2024. $2,910. 2023 $200; 2024 $408. $0 in 2024, $300 in 2025. Gross income of $1,200 may be deferred until 2024. Gross income of $120 ($240 × 3/6) in 2024 for 6-month contract. For 36-month contract, include $210 in 2024 gross income. Gross income $450 ($1,200 − $750). Constructively received $0. She may be in a lower tax bracket in 2026. Report in the year of receipt $0 under option 1, $500 under option 2, and $1,000 under option 3. First option. $126,000 for Rusty. Corporation recognizes $10,000 in 2024; Troy recognizes $0. Same as part a. Corporation recognizes $0 in 2024; Troy recognizes $0 in 2024. $90,000 for each partner. $25,100 ($12,300 + $12,800). $0 tax liability. Stock is better. Bond is better. Doug $51,100; Imani $57,200. Doug $54,150; Imani $54,150. No recognition tax consequences; $50,000 cash might be alimony. $0 alimony. $300 is alimony. Goal is to receive equal value on an after-tax basis. Roy should borrow from Hal. $0. $0. $220. $1,125. $0 imputed interest. $0 imputed interest. Imputed interest $125. Imputed interest $1,500.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

54.a.

54.b.

55.a. 55.b. 55.c. 56.a.

Compensation income and interest expense to Vito $360; compensation expense and interest income to Vito, Inc., $360. Interest income and dividends paid to the corporation in 2024 $160; interest expense and dividend income to Vito in 2024 $160; amount in 2025 is $529. Gross income $16,800. Gross income $36,000. $22,400. $60,000.

56.b. 56.c. 57. 58. 59.a. 59.b. 59.c. 59.d. 60.a. 60.b. 61. 62.

$0. $10,000. $100,905. $15,000. The $150,000 is taxable. $7,140 is taxable. $1,200 is taxable. Donna must include one-half of husband’s winnings. $1,834. $294. Refund due $8,073. Net tax payable $132.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

SOLUTIONS TO ETHICS & EQUITY FEATURES Should the Tax Treatment of Government Bonds and Corporate Bonds Be Different? (p. 4-12). The difference in the tax treatment of U.S. government bonds and corporate bonds appears to be a situation where the law lacks horizontal equity: similar investments are taxed differently. The law can be justified as tax simplification for small investors. Moreover, these types of government bonds are generally purchased by middle-income taxpayers who will not exploit the rules. On the other hand, corporate bonds are largely purchased by wealthy individuals and financial institutions to whom complexity in the law is not a major problem and that would likely find means to exploit the income deferral. The Taxation of Alimony and the Alimony Tax Gap (p. 4-22). Equating the tax treatment of alimony and child support reduces the complexity surrounding the tax consequences of divorce settlements. And the parties to a divorce may alter the terms of the settlement to account for the tax consequences of any payments made between them. However, imposing tax on income that the taxpayer is required to pay to the ex-spouse seems problematic regardless of its impact on tax revenues. And, although compliance and enforcement are important factors to consider, and increased reporting requirements and enforcement efforts may be warranted, potential evasion by either the payor or the recipient of alimony provides little justification for imposing tax on income one is legally obligated to transfer to their exspouse. Stricter reporting requirements could have been implemented instead to ensure that recipients of alimony report it. Taxing “Phantom” Income (p. 4-26). The use of interest-free loans can easily be used to avoid income taxes within the family unit. Suppose, for example, that Christiana is in the 39.6% income tax bracket, and Max’s bracket is 15%. If the $200,000 loan yields income of $20,000, the parties have saved $4,920 ($7,920 − $3,000) annually by channeling the investment through a lowerbracket family member. The imputed interest rules preclude this kind of income shifting. Tax Treatment of Unemployment Compensation (p. 4-30). Treating unemployment income as taxable results in reduced benefits for recipients with sufficient taxable income. This may seem odd when the benefits are intended to assist individuals who have lost their jobs and, generally, this compensation is less than their wages would have been. See what arguments students make for and against this treatment.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

SOLUTIONS TO BECKER CPA REVIEW QUESTIONS 1.

Choice “a” is correct. The maximum amount of taxable Social Security benefits is 85% of Social Security benefits received. Depending on a taxpayer’s level of provisional income (AGI plus tax-exempt interest plus 50% of Social Security benefits), a taxpayer may include 0%–85% of Social Security benefits received in gross income. Taxpayers must include in income the lesser of 50% (or 85%, depending on income) of Social Security received or 50% (or 85%, depending on income) of the excess provisional income over a threshold. 85% of Social Security benefits received is the maximum amount that is includable in gross income. Choice “b” is incorrect. The maximum amount of taxable Social Security benefits is 85% of Social Security benefits received. Choices “c” and “d” are incorrect. If a taxpayer’s only source of income is $10,000 in Social Security benefits, the taxpayer is below the threshold ($25,000 single or $34,000 married) for taxable Social Security benefits.

2. Choice “b” is correct. Alimony pursuant to a divorce or separation agreement executed on or before 12/31/18 is taxable to the recipient and deductible by the payor. Child support is not taxable to the recipient and not deductible by the payor. Because the total payment decreases to $10,000 once Fred and Wilma’s child turns 18, the $2,000 decrease is deemed child support. The fact that Fred pays the law school in accordance with the divorce agreement on Wilma’s behalf does not change the fact that $10,000 is considered alimony. Choice “a” is incorrect. The fact that Fred pays the law school in accordance with the divorce agreement on Wilma’s behalf does not change the fact that $10,000 is considered alimony. Choice “c” is incorrect. Alimony paid in accordance with a divorce or separation agreement executed on or before 12/31/18 is taxable to the recipient and deductible by the payor. Child support is not taxable to the recipient and not deductible by the payor. Because the total payment decreases to $10,000 once Fred and Wilma’s child turns 18, the $2,000 decrease is deemed child support. Choice “d” is incorrect. Alimony paid according to a divorce or separation agreement executed on or before 12/31/18 is taxable to the recipient and deductible by the payor. 3. Choice “d” is correct. If a divorce settlement provides for a property settlement by a spouse, the spouse gets no deduction for payments made, and the payments are not includable in gross income of the spouse receiving the payment. Choice “a” is incorrect. Because the divorce settlement provides for the payments, no deduction is allowable for payments made, and the payments are not includable in gross income of the spouse receiving the payment. Choice “b” is incorrect. If a divorce settlement provides for a property settlement by a spouse, the amounts are generally nontaxable. Choice “c” is incorrect. If a divorce settlement provides for an assumption of debt by a spouse, the amounts are generally nontaxable.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

4. Choice “b” is correct. Alimony paid on a divorce or separation agreement executed on or before 12/31/18 is deductible as a for AGI deduction. The regular alimony payments are deductible, but the child support is not. The residence was a property settlement and is not part of deductible alimony. Choice “a” is incorrect. The regular alimony payments are deductible because the divorce was executed prior to 2019. Choice “c” is incorrect. This amount includes the child support, which is not deductible. Choice “d” is incorrect. This amount includes the child support and the property settlement, both of which are not deductible. 5. Choice “b” is correct. Based on IRS tables, Mary is expected to receive 192 (16 years × 12 months) annuity payments. Her investment in the annuity is $70,000 and her return of capital for each annuity payment is $70,000 ÷ 192 = $364.58. The return of capital portion of each annuity payment is not taxable (not included in gross income). Mary must include the excess received ($500.00 – $364.58) of $135.42 in her gross income. Choice “a” is incorrect. Based on IRS tables, Mary is expected to receive 192 (16 years × 12 months) annuity payments. Her investment in the annuity is $70,000. Therefore, her return of capital for each annuity payment is $70,000 ÷ 192 = $364.58, which is not taxable. She must include the excess $135.42 in her gross income. Choice “c” is incorrect. This is equal to the amount that is a nontaxable return of investment on the annuity, rather than the taxable income portion of each payment. Choice “d” is incorrect. Mary is not subject to tax on the portion of the payment that is a return of investment. This is calculated using the IRS life expectancy tables, and excess amounts are recognized ratably over that period. 6. Choice “b” is correct. Alimony received based on a divorce agreement executed on or before 12/31/18 is taxable as gross income to the recipient. Choice “a” is incorrect. Child support received is not taxable as gross income. Choice “c” is incorrect. Child support received is not taxable as gross income. Choice “d” is incorrect. Alimony received based on a divorced agreement executed after 12/31/18 is not taxable as gross income to the recipient. 7. Choice “c” is correct. Imputed interest on an interest-free loan is subject to gift tax for each year the loan is outstanding. Choice “a” is incorrect. Imputed interest on an interest-free loan is subject to gift tax for years other than only the year the parents loaned the money. Choice “b” is incorrect. Imputed interest on an interest-free loan is subject to gift tax for years other than only the year the child paid back the loan. Choice “d” is incorrect. An excise tax does not apply to imputed interest on an interest-free loan.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

8. Choice “c” is correct. The Kales’ transactions net to a $8,500 loss on the sales. The current year transactions should be netted first, then additional amounts up to $3,000 can be used to offset ordinary income. 9. Choice “c” is correct. In year 9, Marsha and Brad had a net capital loss of $17,000, of which an additional $3,000 can be used to offset income from other sources (e.g., the ordinary income from employment) in the current year. This would reduce the carryforward to $14,000. Choice “a” is incorrect. Taxpayers are limited to a maximum capital loss of $3,000 offsetting income from other sources (after offsetting any appropriate capital gains). Therefore, the net total $17,000 loss on the sale of the stock cannot be used in the year it is incurred. Choice “b” is incorrect. Capital losses can offset any gains in the year incurred, and then a maximum of $3,000 of income from other sources can be offset with capital losses. Choice “d” is incorrect. Choice “d” is the net of the current year loss and gain; however, an additional $3,000 of the loss can be recognized in the current year. 10. Choice “a” is correct. For gift loans between individuals of $100,000 or less, the imputed (foregone) interest is limited to the amount of the borrower’s net investment income for the year. If the borrower’s net investment income is $1,000 or less, the imputed interest is treated as zero. Choice “b” is incorrect. This amount is the difference between the $750 interest based on the current AFR ($25,000 × 3%) and the borrower’s net investment income of $500. Since the loan is a gift loan between individuals of $100,000 or less, and the borrower’s net investment income is $1,000 or less, the imputed interest is treated as zero. Choice “c” is incorrect. Since the loan is a gift loan between individuals of $100,000 or less, the imputed interest would be limited to the borrower’s net investment income of $500. However, since the net investment income is $1,000 or less, the imputed interest is treated as zero. Choice “d” is incorrect. This amount is the imputed interest on the loan based on current AFR ($25,000 × 3% = $750). However, since the loan is a gift loan between individuals of $100,000 or less, and the borrower’s net investment income is $1,000 or less, the imputed interest is treated as zero. 11. Choice “b” is correct. Bridgett would only have to include in interest income the amount of interest actually paid by her nephew ($6,000 × 1% = $600). Although the loan is a below-market loan, there is a de minimis exception to the imputed interest rules for gift loans between individuals (friends and family members) of $10,000 or less. Choice “a” is incorrect. Although the imputed interest rules do not apply to the $6,000 loan under the de minimis exception, Bridgett would still need to include the actual interest received from her nephew in her taxable interest income.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 4: Gross Income: Concepts and Inclusions

Choice “c” is incorrect. This amount is the imputed interest, which is the difference between the interest based on the 2.5% AFR and the 1% stated interest rate on the loan ($6,000 × (2.5% – 1.0%) = $90). Only the actual interest received, not the imputed interest, is included in Bridgett’s taxable income because the amount of the loan is $10,000 or less. Choice “d” is incorrect. This amount is the interest based on the 2.5% AFR ($6,000 × 2.5% = $150). Only the actual interest received is included in Bridgett’s taxable income because the amount of the loan is $10,000 or less.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

Solution and Answer Guide

YOUNG, PERSELLIN, NELLEN, MALONEY, CUCCIA, LASSAR, CRIPE, SWFT COMPREHENSIVE VOLUME 2025, 9780357988817; CHAPTER 5: GROSS INCOME EXCLUSIONS

TABLE OF CONTENTS Discussion Questions...........................................................................................................1 Computational Exercises ................................................................................................... 4 Problems ............................................................................................................................. 7 Tax Return Problems ........................................................................................................ 18 Research Problems ........................................................................................................... 20 Check Figures.................................................................................................................... 23 Solutions To Ethics & Equity Features ............................................................................ 24 Solutions To Becker CPA Review Questions ................................................................... 25

DISCUSSION QUESTIONS 1.

(LO 1, 2) The $10,000 that John received is compensation for services and, therefore, must be included in his gross income; no exclusion applies to this income. The $100,000 that John inherited is income but excluded per a specific tax rule on this type of income. Finally, the $5,000 that John borrowed is not income because he has an offsetting liability to repay this money, so there is no accession to wealth.

2. (LO 2) Leonard must include $2,500 in his gross income. Because $2,500 was received from his employer, it cannot qualify as a nontaxable gift, and no other exclusion provision would apply. However, the amount received from his fellow employees was made out of detached generosity and, therefore, is a nontaxable gift. The amount Leonard spent to repair the damage is not relevant to determining his gross income, although the cost may be partially deductible as a personal casualty loss. 3. (LO 2) Megan should include $92 in her gross income. Even if the funds were received as the result of a mistake, she has the free and unrestricted use of the funds with no apparent claims against the funds. In addition, because she received the amount from a customer in her employment capacity, it is unlikely that she received a nontaxable gift. 4. (LO 2) Carey must include all of her tips in gross income. Although the customers have no legal obligation to pay her, in fact, the payments are for her services to the customer. Therefore, the payments are compensation for services. 5. (LO 2) Assuming that Lime had taxable income in 2023 of at least $5,000, it received a tax benefit from writing off the receivable. So, Lime would include $3,500 in gross income in

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

2024 under the tax benefit rule. The insurance proceeds could not be excluded from gross income because the insurance contract proceeds were in consideration of the loan and not payable merely as the result of Wally’s death. 6. (LO 2) No. Billy’s award of $150,000 can be excluded from gross income because it arose out of a physical personal injury even though $50,000 was to replace income he would have earned and would have been subject to tax. The $15,000 he received from the income replacement policy he purchased is excluded from Billy’s gross income as a recovery of his cost of the policy (but is not taxable even though the total benefit received may exceed the premiums paid). Amber is taxed on the $30,000 she received under the income replacement insurance policy because the premiums were paid by her employer (and would not have been included in her gross income). 7. (LO 2) No. The $10,000,000 amount that Wes received is included in his gross income. However, Sam is required to include only the $4,000,000 in punitive damages in his gross income. His compensatory damages are excluded from his gross income, even though the amount replaces a loss of income, because the amount was received as a result of physical personal injury. 8. (LO 2) Holly can exclude the $12,000 of workers’ compensation benefits she received from her gross income. Jill can exclude the $12,000 she received for lost income because it was received from an insurance policy she had purchased. 9. (LO 2, 4) Both Casey and Mei will experience a decrease in income net of health insurance premiums. It is merely a question of which option is “less objectionable.” As will be seen, Casey is $800 better off under option (1), whereas Mei is $1,500 better off with option (2). Under option (1), Casey is required to pay $8,000 in premiums each year. Assuming that he cannot deduct the insurance as a medical expense because of the 7.5%-of-AGI floor, his cash flow after-tax and health insurance premiums decrease by $8,000. Under option (2), Casey’s cash flow after-tax and health insurance premiums decrease by $8,800 [(1 − 0.12) × $10,000]. Therefore, Casey is better off with option (1). Mei fares much better under the second option. As in Casey’s case, with option (1), she is $8,000 poorer than without any change. But under option (2), her after-tax cash flow decreases by $6,500 [(1 − 0.35) × $10,000]. Therefore, Mei is better off with option (2). 10. (LO 2) The $100,000 is includible in Anh’s gross income. While she did suffer physical injuries, the lawsuit that produced the award was related to the law firm malpractice claim, not her physical injuries. While it may appear that the damages replace what she failed to win from the hospital (due to legal malpractice), the tax law only allows an exclusion for damages for physical injury; Anh’s damages were received for a legal injury. This is similar to the situation in Debra Blum, 121 TCM 1147, T.C.Memo. 2021-18. 11. (LO 2) The discount on the price of the automobile of $4,600 ($33,600 − $29,000) is a qualified employee discount. The discount can be excluded from Ted’s gross income because the price he paid was above the employer’s cost. However, Ted must include in gross income 80% of the dealer preparation fee, a service, of $300, which is $240 ($300 × 80%). The maximum qualified employee discount that can be excluded for a service is 20%.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

12. (LO 2, 4) The additional before-tax salary that is required to purchase the health insurance for $9,000, when the marginal tax rate is 24%, is $11,842 [$9,000 ÷ (1 − 0.24)]. This assumes that Wilbur will not be able to deduct the insurance as a medical expense because of the 7.5%-of-AGI floor and/or the standard deduction. 13. (LO 2, 4) a. Tom must include the $100 in gross income. Mason is allowed to exclude the $100 as a qualified transportation fringe. b. Tom paid $100 for transportation cost and was reimbursed for that amount. Therefore, Tom’s before-tax cost was $0. However, Tom is required to include the $100 in gross income and thus must pay an additional $24 ($100 × 0.24) tax on the reimbursement, which is his after-tax cost of commuting. Mason’s after-tax cost of commuting is $0 because he is reimbursed for the outof-pocket cost and is not required to include the reimbursement in income. 14. (LO 2) The issues all relate to whether the employees would realize gross income from the employer providing the facilities. If the employee does have gross income, the next question is whether the benefit qualifies under one of the exclusions provided in the Code. •

Does the employee experience an economic benefit from using the facility?

•

Does the walking trail qualify as an excludible “athletic facility”?

•

Is the benefit de minimis?

•

Is the benefit a no-additional-cost service? Valuation of the benefit also could be an issue.

15. (LO 2) The facility provides an opportunity to provide the employees with nontaxable income. The child day care services and exercise facility provided to the employees are specifically excluded from their gross income. 16. (LO 2, 4) The Virginia bond yields the greatest after-tax income.

Before-tax interest (on $100,000) Virginia tax @ 5% Federal tax benefit from Virginia tax @ 35% Federal tax After-tax income

Virginia Bond $4,500 –0– –0– –0– $4,500

North Carolina Bond $4,600 (230) 81 –0– $4,4 5 1

17. (LO 2) a. Andrea must include $10,000 ($25,000 − $15,000) in her gross income (i.e., the fund earnings). She also will be subject to a 10% additional tax, reported on Form 5329. b. Both Andrea and Joanna can exclude the $7,500 from their gross income because this amount was used to pay for higher education expenses.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

18. (LO 2) •

Did the mortgage holder sell the property to Ralph?

•

Is the friend forgiving the debt as a gift to Ralph?

•

Is Ralph insolvent or undergoing bankruptcy proceedings?

•

If Ralph must recognize income from the debt cancellation, does he have losses to offset?

•

May Ralph reduce the basis of the asset rather than recognize income?

19. (LO 2) The $80,000 raised from the crowdfunding seems like a gift as donors gave money without any expectation in return. That is, the amounts were given out of detached generosity. However, the facts indicate that Kiara took time off of work (meaning she is employed). Kiara will need to review a list of those who provided the $80,000. If Kiara’s employer is on that list, any amount provided by her employer is not a gift; rather, it must be included in her gross income. Also, see IRS Fact Sheet FS–2022–20 (March 2022) and § 102. 20. (LO 3) Dolly is not required to recognize income in 2024 from the receipt of the state income tax refund of $2,200. The refund merely corrects for her overpayment, and the original payment did not affect her taxable income because she claimed the standard deduction on her 2023 tax return. On the other hand, Molly received a tax benefit in the form of a deduction on her 2023 Federal income tax return. As a result, the $600 refund she receives in 2024 is the recovery of a tax benefit. Whether Dolly and Molly itemize deductions in the year of recovery (2024) is not relevant to whether they realized gross income from the recovery of 2023 state income taxes.

COMPUTATIONAL EXERCISES 21. (LO 2) Generally, long-term care insurance, which covers expenses such as the cost of care in a nursing home, is treated the same as accident and health insurance benefits. Thus, the employee does not recognize income when the employer pays the premiums. Also, the individual who purchases his or her own policy can exclude the benefits from gross income. However, statutory limitations (indexed for inflation) exist for the following amounts: •

Premiums paid by the employer.

•

Benefits collected under the employer’s plan.

•

Benefits collected from the individual’s policy.

The employer or insurance company generally provides the employee with information on the amount of his or her taxable benefits. The maximum amount excluded must be reduced by any amount received from third parties (e.g., Medicare, Medicaid).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

The amount Valentino may exclude is calculated as follows: Greater of: Daily excludible amount in 2024 ($410 × 45 days) Actual cost of the care Less: Amount received from Medicare Equals: Amount of exclusion

$18,450 13,500

$18,450 (8,000) $10,450

Therefore, Valentino must include $4,550 ($15,000 − $10,450) of the long-term care benefits received in his gross income. 22. (LO 2) Under this global system, a U.S. citizen who earns income in another country could experience double taxation: the same income would be taxed in the United States and in the foreign country. Out of a sense of fairness and to encourage U.S. citizens to work abroad (so that exports might be increased), Congress has provided alternative forms of relief from taxes on foreign earned income. The taxpayer can elect either (1) to include the foreign income in his or her taxable income and then claim a credit for foreign taxes paid or (2) to exclude the foreign earnings from his or her U.S. gross income (the foreign earned income exclusion). Foreign earned income consists of the earnings from the individual’s personal services rendered in a foreign country (other than as an employee of the U.S. government). To qualify for the exclusion, the taxpayer must have a tax home in a foreign country and be either of the following: •

A bona fide resident of the foreign country (or countries).

•

Present in a foreign country (or countries) for at least 330 days during any 12 consecutive months.

The amount of the foreign earned income exclusion changes each year. Persons who qualify are eligible to exclude up to $126,500 in foreign earned income for 2024. Mio’s exclusion is limited to $117,519, computed as follows: $126,500 (2024 limit) × (340 days in Germany ÷ 366 in the year; 92.90%) = $117,519. 23. (LO 2) Life insurance proceeds paid to the beneficiary because of the death of the insured are exempt from income tax. Congress chose to exempt life insurance proceeds for the following reasons: •

For family members, life insurance proceeds serve much the same purpose as a nontaxable inheritance.

•

In a business context (as well as in a family situation), life insurance proceeds replace an economic loss suffered by the beneficiary.

The $500,000 Jason receives is exempt from Federal income tax. 24. (LO 2) Generally, if the owner of a life insurance policy cancels the policy and receives the cash surrender value, the taxpayer must recognize gain equal to the excess of the amount received over premiums paid on the policy (a loss is not deductible). The gain is recognized because the general exclusion provision for life insurance proceeds applies only to life insurance proceeds paid upon the death of the insured. If the taxpayer cancels the policy and receives the cash surrender value, the life insurance policy is treated as an investment by the insured. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

In a limited circumstance, however, the insured is permitted to receive the benefits of the life insurance contract without having to include the gain in gross income. Under the accelerated death benefits provisions, exclusion treatment is available for insured taxpayers who are either terminally ill or chronically ill. A terminally ill taxpayer can collect the cash surrender value of the policy from the insurance company or assign the policy proceeds to a qualified third party. The resultant gain, if any, is excluded from the insured’s gross income. A terminally ill individual is a person whom a medical doctor certifies as having an illness that is reasonably expected to cause death within 24 months. Therefore, Alfred is not required to include the $106,700 gain ($125,000 − $18,300) on the sale of the policy in his gross income. 25. (LO 1, 2) There are exceptions to the general rule that life insurance proceeds paid to the beneficiary because of the death of the insured are exempt from income tax. A life insurance policy (other than one associated with accelerated death benefits) may be transferred after it is issued by the insurance company. If the policy is transferred for valuable consideration, the insurance proceeds are includible in the gross income of the transferee to the extent the proceeds received exceed the amount the transferee paid for the policy plus any subsequent premiums paid. Therefore, Tyler must include $16,000 [$25,000 proceeds − ($7,500 paid for policy + $1,500 in subsequent premiums)] in his gross income. 26. (LO 1, 2) Payments or benefits received by a student at an educational institution may be (1) compensation for services, (2) a gift, or (3) a scholarship. If the payments or benefits are received as compensation for services (past or present), the fact that the recipient is a student generally does not render the amounts received nontaxable. The scholarship rules are intended to provide exclusion treatment for educationrelated benefits that cannot qualify as gifts but are not compensation for services. According to the Regulations, “a scholarship is an amount paid or allowed to, or for the benefit of, an individual to aid such individual in the pursuit of study or research.” The recipient must be a candidate for a degree at an educational institution. A scholarship recipient may exclude from gross income the amount used for tuition and related expenses (fees, books, supplies, and equipment required for courses), provided the conditions of the grant do not require that the funds be used for other purposes. Jarrod may exclude $13,500 ($12,000 tuition + $1,500 books and supplies) from his gross income. The $4,000 spent for room and board and $1,000 spent for personal expenses are includible in Jarrod’s gross income. 27. (LO 3) Generally, if a taxpayer obtains a deduction for an item in one year and in a later year recovers all or a portion of the prior deduction, the recovery is included in gross income in the year received. However, the § 111 tax benefit rule provides that no income is recognized upon the recovery of a deduction, or the portion of a deduction, that did not yield a tax benefit in the year it was taken. For example, if a taxpayer had no tax liability in the year of the deduction (e.g., itemized deductions and personal exemptions exceeded adjusted gross income), the recovery would be partially or totally excluded from gross income in the year of the recovery.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

a. Because the standard deduction in 2023 was $27,700, the $7,000 of state income taxes Myrna and Geoffrey paid in 2023 yielded a tax benefit of only $700 ($28,400 itemized deductions − $27,700 standard deduction) in 2023. Under the tax benefit rule, only $700 of the state income tax refund is included in gross income in 2024. b. While Veronica had state and local taxes of $30,000 ($13,000 local property taxes + $17,000 state income taxes), she was able to deduct only $10,000 due to the SALT cap. None of the $2,100 state income tax refund is taxable because she received no tax benefit from it; even if the state income tax refund was received in 2023, Veronica would still be subject to the SALT cap of $10,000.

PROBLEMS 28. (LO 2) The $10,000 received from the general public is an excludible gift. The $12,000 that Ed’s widow received in her “time of need” may be excluded from gross income if the company has a general policy of making such payments. Otherwise, the IRS may challenge the payment as a taxable payment for Ed’s prior services. The $25,000 debt canceled by the hospital should not increase gross income. This results because to the extent the debt cancellation is included in gross income, Ed should be allowed a medical expense deduction that is subject to the 7.5%-of-AGI floor. The debt attributable to the nondeductible portion should be excluded from gross income under the tax benefit rule because the recovery of the expense is excluded from gross income to the extent the expense did not yield a tax benefit. The life insurance proceeds are excluded from gross income because they were paid to the beneficiary of a life insurance policy. 29. (LO 2) a. The payments received for not working must be included in Justin’s gross income because he experienced an increase in wealth when the payment was received (although he may experience a decrease in future income). b. The payments received by Trina must be included in her gross income. The payments were not gifts, although they were made because of her dire circumstances, because the Internal Revenue Code specifically provides that employers cannot be considered donors to their employees. c. The life insurance proceeds are excluded from Coral Corporation’s gross income. The corporation collected the proceeds as the beneficiary of the policy upon the death of the insured. d. The life insurance proceeds of $40,000 are excluded from Juan’s gross income. He collected the proceeds as the beneficiary of the policy upon the death of the insured. The fact that the corporation paid the premiums and the premiums were excluded from Leon’s gross income does not affect the tax treatment of the proceeds. The accrued salary of $3,500 must be included in Juan’s gross income because it would have been taxable to Juan’s husband if he had collected it (“income in respect of a decedent”).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

30. (LO 2, 4) a. The sale of the stock by Laura will result in a $15,000 ($50,000 amount realized − $35,000 adjusted basis) capital gain. However, in 2024, Laura’s capital gain rate may be 0% if her taxable income is less than $47,025 (for a single filer). If her taxable income is between $47,025 and $518,900 (for a single filer), her alternative tax rate will be 15%. So her tax liability on the $15,000 capital gain could be as high as $2,250 ($15,000 × 15%) or as low as $0 ($15,000 × 0%). If Laura is diagnosed as “terminally ill,” the realized gain on the life insurance policy of $20,000 ($50,000 − $30,000) is excluded from her gross income. b. Capital gain treatment would apply to the sale of the stock by Laura’s mother. The $20,000 realized gain on the life insurance policy will be included in the gross income of Laura’s mother. Laura’s mother cannot qualify for the exclusion because she is not terminally ill. The mother’s recognized gain of $20,000 will not be eligible for capital gain treatment because cashing in the life insurance policy is not considered a “sale or exchange,” which is a requisite for capital gain treatment. Regardless of how the medical bills are financed, Laura’s mother will be allowed to take an itemized deduction for the medical expenses paid (less the 7.5%-of-AGI floor) for her dependent daughter, assuming that she itemizes her deductions. 31. (LO 2) a. $50,000 salary. b. $3,000, the value of the trip. c. The $10,000 is compensation unless this is paid under a nondiscriminatory medical reimbursement plan available to other employees. d. The $15,000 is taxable as compensation; because it was paid after the spouse’s death, it is considered income in respect of a decedent. e. Zero. Life insurance proceeds paid to the beneficiary upon death of the insured are excluded from gross income. 32. (LO 2) Darlene’s gross income from the receipts is $86,000.

a. Employer payments, not excluded as gift. The fact that the payment is part of company policy provides the earmarks of compensation rather than a gift. b. Accrued salary, earned before death. c. Group term life insurance proceeds. d. Annuity proceeds Less: Recovery of capital ($600,000* ÷ $750,000**) × $30,000

Amount Received $ 60,000

Gross Income $60,000

$ 20,000 $480,000 $ 30,000

20,000 –0–

(24,000)

6,000 $86,000

*Investment in contract: nontaxable $600,000 insurance proceeds. **Expected return: $30,000 × 25 years.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

33. (LO 2) a. Ray is the beneficiary of the life insurance policy and can exclude the proceeds of $800,000 from his gross income. b. Yes, the $16,000 of interest earned on the life insurance proceeds left with the insurance company is included in Ray’s gross income. c. Ray did not recognize a gain on the bargain purchase. Ray simply got a good price on the purchase under an arm’s length contract. 34. (LO 2) a. The $16,500 received for tuition, fees, books, and supplies can be excluded from Sally’s gross income as a scholarship. The $6,000 received for room and board and the $1,200 received for transportation must be included in her gross income. The athletic scholarship is considered a payment to further the recipient’s education and is not compensation for services. b. The $8,000 “scholarship” is additional compensation to Willy’s father. The fact that the “scholarships” are awarded only to the children of executives indicates that the employer is not simply making payments to assist the student seeking his or her education but rather to compensate an employee. However, the $6,000 scholarship received as a contest winner is excluded from gross income. Although contest winnings are generally subject to tax, the exception is when the prize is a scholarship. 35. (LO 2) Adrian received a total of $13,700 and spent $9,650 ($3,700 + $3,750 + $1,000 + $1,200) on tuition, books, and supplies. The amount received for room and board is not excludible from gross income. As a result, he must include $4,050 ($13,700 − $9,650) in gross income. When he received the money in 2024, Adrian’s total expenses for the period covered by the scholarship were not known. So, he is allowed to defer reporting the income until 2025, when all the uncertainty is resolved. 36. (LO 2) a. Leigh must include in gross income the punitive damages of $80,000. The other amounts ($15,000 and $6,000) may be excluded as arising out of the physical personal injury, except the $3,300 amount received for damage to her automobile. This amount is a nontaxable recovery of capital (i.e., it reduces her basis for the automobile by $3,300). b. The $25,000 is included in Leigh’s gross income because it did not arise out of a physical personal injury. 37. (LO 2) a. The settlement in the sex discrimination case did not arise out of physical personal injury or sickness. Therefore, the $150,000 is included in Eloise’s gross income. b. The damages to Nell’s personal reputation are not for physical personal injury or sickness. Therefore, Nell must include the $10,000 in her gross income. She must also include the $40,000 punitive damages in her gross income.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

c. The damages of $50,000 are included in Orange Corporation’s gross income under the tax benefit rule, assuming that the company received tax benefit from deducting the audit fees in a previous year. d. The compensatory damages of $10,000 for the physical personal injury are not included in Beth’s gross income, but the punitive damages of $30,000 must be included in her gross income. e. Because the compensatory damages of $75,000 arose from a physical personal injury, they are excluded from Joanne’s gross income. The punitive damages of $300,000 are included in her gross income. 38. (LO 2) Rex is required to include in gross income the $4,500 received from the wage continuation policy while he was ill. This amount is included in gross income because the employer paid for the policy. The other items can be excluded from gross income. 39. (LO 2)

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040

September 27, 2024 UVW Union 905 Spruce Street Washington, DC 20227 Dear Union Members: You asked me to explain the tax consequences of HON Corporation’s proposed changes in the employees’ compensation package. The proposed changes include (1) the elimination of the $250 deductible clause in the medical benefits plan, (2) an additional paid holiday, and (3) a cafeteria plan that would allow the employee to receive cash rather than medical insurance. The deductible clause will benefit each employee in the amount of $250 each year. That is, the employee will have an additional $250 for the same medical benefits that the employee presently receives and, generally, none of the $250 will be includible in arriving at taxable income. The additional paid holiday will have no effect on after-tax income—the employee’s annual gross income will not change. The cafeteria plan will mean that some employees who now have excess medical coverage can substitute cash for the unneeded protection. The cash received will be taxable, but the employee’s after-tax income will increase. In summary, the change with the broadest tax implications is the elimination of the $250 deductible for medical benefits. The effect on the employee will be the same as a $329 raise ($250 ÷ 0.76). Also, the cafeteria plan may be important for some employees, depending upon how many of them have working spouses whose employers provided medical benefits for the employee’s entire family.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

Please contact me if you have further questions. Sincerely yours, John J. Jones, CPA Partner 40. (LO 2, 4) With a medical reimbursement plan, Mauve would be paying all of an employee’s medical expenses. The employee would have no incentive to control costs. With the flexible benefit plan, the employee must contribute to the costs through a salary reduction under the flexible benefit plan. Therefore, for this plan, the employee has an incentive to minimize costs. 41. (LO 2) None of the benefits received must be included in her gross income. The amount Belinda may exclude is calculated as follows: Greater of: Daily excludible amount in 2024 ($410 × 60 days) Actual cost of the care ($300 × 60 days) Less: Amount received from Medicare Available exclusion amount

$24,600 18,000

$24,600 (8,500) $16,100

Belinda’s available exclusion amount ($16,100) is greater than the benefits she received ($7,500); as a result, none of the benefits received is included in her gross income. 42. (LO 2) The concern in this situation for Tim is that the house will not be considered “on the employer’s premises” for Tim to qualify for the meal and lodging exclusion. However, Tim could effectively argue that the house is an extension of the employer’s office because of the extensive business activities (communications, entertaining) conducted in the house. He should be prepared to document the extent of business activities conducted at the house. The presence of an administrative assistant would suggest that much more than incidental business activities are conducted in the home. Gross income would include $70 ($385 − $315) per month for parking because the benefit exceeds the qualified parking monthly exclusion limit for 2024 of $315. 43. (LO 2) a. It appears that Ava’s meals are not provided for the convenience of the employer but, rather, as a convenience for the employee. Thus, this is a taxable fringe benefit. Therefore, Ava is required to include $10 per meal in gross income. This is the difference between the amount she paid for the meals, $2, and the amount she would be required to pay of $12 to an unrelated restaurant. A comparison to the poorer quality of the self-prepared lunch is not a valid measure of the benefit she actually received. b. Scott is not required to include anything in gross income for the use of the condominium assuming that the lodging is for the convenience of the employer, and he is required to accept this lodging as a condition of his employment. Because of the close proximity of the condominium to the office, the condominium is considered to be on the employer’s business premises.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

c. Apparently Ira is not being provided the housing for the convenience of his employer. However, the use of the apartment should qualify as a no-additionalcost service because the apartment would otherwise be vacant. 44. (LO 2, 4) Only Bertha can decide whether she should take early retirement. As an aid in making her decision, you can inform her that her disposable income after the effect of the revisions created by retirement will decrease by approximately $15,000 a year, or by substantially less than 50% of her current after-tax income.

Salary/retirement Reduced commuting and clothing costs Social Security and Medicare tax Income tax* Medical insurance

Now $55,000 (3,600) (4,208) (8,875) (–0–) $38,317

Retired $36,000 (–0–) (–0–) (4,695) (8,000) $23,305

Disposable income associated with employment Less: Disposable income associated with retirement Decrease in disposable income

Disposable Income

$38,317 (23,305) $15,012

*Income tax of $8,875 – [0.22($55,000 – $36,000)] = $4,695. 45. (LO 2, 4)

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040

September 18, 2024 Finch Construction Company 300 Harbor Drive Vermillion, SD 57069 Dear Management: You asked me to determine the tax implications of requiring the company’s employees who are carpenters to furnish their own tools, with a compensating increase in their salaries of about $1,500 each. In short, most employees would experience a net decrease in after-tax income. Under the company’s present way of doing business, the carpenters do not recognize income when the employer provides tools. This is a “working condition fringe.” If the employee’s salary is increased, and they purchase the necessary tools, the employee must include the additional $1,500 in salary in gross income. The cost of the tools will not be deductible. Another possibility would be for the employees to purchase the tools but account to you for their cost and obtain reimbursement. Under this plan, the employee would be allowed to directly offset the reimbursement with the expense in arriving at adjusted gross income. The request for reimbursement would also provide you with a means of controlling costs.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

Please contact me if you would like to discuss this further. Sincerely, Amy Evans, CPA Partner 46. (LO 2, 4) a.

Low $ 9,000

High $ 9,000

0.12 0.0765 0.1965 0.8035

0.24 0.0145 0.2545 0.7455

$1 1 ,2 0 1

$12,072

b. Before tax compensation Employer’s Social Security tax rate Employer’s Social Security tax Total before income tax cost to employer Less: Employer’s tax benefit (@ 25%) Employer’s after-tax cost of taxable Compensation

$1 1 , 2 0 1 0.0765 857 $12,058 (3,0 1 5)

$12,072 0.0145 175 $12,247 (3,062)

$ 9,043

$ 9,1 8 5

c. Exempt compensation to employees Less: Employer’s tax benefit (@ 25%) Employer’s after-tax cost of exempt benefit

$ 9,000 (2,250) $ 6,750

Benefits Income tax rate Social Security and Medicare tax rate Total marginal tax rate (MTR) 1 − MTR Before tax compensation = [$9,000 ÷ (1 − MTR)]

d. For an after-tax cost of $6,750 per employee, Bluebird can provide tax-exempt benefits to its employees that are equivalent to before-tax taxable compensation of $11,201 and $12,072, respectively, depending on the employee’s marginal tax bracket. It would cost the company $9,043 and $9,185 to provide the taxable compensation equivalent of $9,000 tax-exempt income. Both the employer and the employee benefit from the exemption. Note, however, that, if an employee is already covered in a similar medical benefit plan under a spouse’s plan, the employee may want the cash compensation instead. 47. (LO 2, 4) a. If Rosa underfunds the account by $1,000, the cost of the error is her marginal tax rate times the underfunded amount, or $240 (24% × $1,000). b. If Rosa overfunds the account by $1,000, the cost of the error is $760 [(1 − 0.24) × $1,000]. c. The cost of underfunding is a 0.24 error, and the cost of overfunding is a 0.76 × (1 − 0.24) error; that is, the underfunding error costs only 32% (0.24 ÷ 0.76) of the cost of overfunding. d. Rosa should fund the flexible benefit account using an amount closer to the low end than the high end of the estimate.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

48. (LO 2) Polly is both an employee and a controlling shareholder in the corporation. Therefore, benefits she receives that are not excludible from gross income may be characterized as a dividend. This means that she might enjoy the lower tax rate applicable to dividends as compared to compensation; however, the corporation will not be allowed to deduct any amount that is considered a dividend. a. The $1,500 cost of the retirement planning seminar can be excluded from Polly’s gross income because it is provided on a nondiscriminatory basis. b. Employee parking is specifically excluded from gross income. However, the value of Polly’s free parking of $4,380 ($365 per month) exceeds the permitted exclusion amount of $3,780 ($315 per month in 2024). So, Polly must include $600 ($4,380 − $3,780) in her gross income. Note that parking can be provided on a discriminatory basis. c. The use of the phone is excluded from Polly’s gross income because it fits the requirements for a de minimis fringe benefit. It is not cost effective to track and record the cost of personal phone calls. d. The value of the use of the condominium is a no-additional-cost fringe benefit that Polly can exclude from gross income. e. The freight is a no-additional-cost benefit made available to all employees (nondiscriminatory). The $750 can be excluded from Polly’s gross income. f.

The plan is discriminatory. Therefore, the highly compensated employees must pay tax on all of their discounts. Polly includes $900 in her gross income.

49. (LO 2) 2024 For the 12-month period ending May 31, 2025, George satisfies the 330-day requirement (i.e., he was in London and Paris for 365 days). As a result, he qualifies for the foreign earned income exclusion treatment for this period, which includes 214 days in 2024 (the months of June through December 2024). For 2024, George can exclude the following amount from his gross income: 2 14 days 366 days

× $126,500* = $73,964

*Lower of earned income of $275,000 or indexed ceiling of $126,500 for 2024. George must include $201,036 ($275,000 − $73,964) in his gross income for 2024. 2025 For the 12-month period ending December 31, 2025, George satisfies the 330-day requirement (i.e., he was in London and Paris for 365 days). As a result, he qualifies for the foreign earned income exclusion treatment for this period, which includes 365 days in 2025. For 2025, George can exclude the following amount from his gross income: 365 days 365 days

× $126,500* of salary = $126,500

*Lower of earned income of $300,000 or indexed ceiling of $126,500 for 2025 (assumed unchanged from 2024). George must include $173,500 ($300,000 – $126,500) in his 2025 gross income. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

50. (LO 2, 3) Hazel must include all of the items in gross income except the interest received of $700 on Augusta County bonds and the $350 patronage dividend. The patronage dividend is not included in gross income under the tax benefit rule because the cost of the materials used on her lawn and garden were not deducted. All other items are simply gross income not otherwise excluded. Therefore, Hazel must include in gross income $1,400 ($800 + $400 + $200). 51. (LO 1) a. Ezra must include $1,000 in gross income, the amount of cash he could have received. b. The stock dividend is nontaxable because he did not have the option of receiving cash. c. Ezra must recognize the income he realized in 2024 of $1,000. He is not permitted to deduct an economic loss until realization occurs (i.e., when he sells the shares). 52. (LO 2) The California bond has the greatest after-tax yield: California Bond Before-tax interest (on $100,000) $3,300 Federal tax @ 35% –0– California tax @ 5% –0– Fed. tax benefit from California tax @ 35% –0– After-tax income $3,300 53. (LO 2)

Corporate Bond $5,200 (1,820) (260) 91 $3,2 1 1

U.S. Gov. Bond $4,600 (1,610) –0– –0– $2,990

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040

September 9, 2024 Ms. Lynn Swartz 100 Myrtle Cove Fairfield, CT 06824 Dear Lynn: You asked me to consider the tax-favored options for accumulating the funds for Eric’s college education. An added complication (and opportunity for tax planning) in your case is that the funds will come from your parents, who are in a much higher tax bracket than either you or Eric. Various options are discussed below. Within some of the options, suboptions are available (i.e., your parents could give the funds to you or to Eric before the investments are made). •

Your parents could purchase stock certificates, bonds, certificates of deposit, or other investments in Eric’s name with them as custodian. The first $1,300 of any income is not subject to tax, as Eric is allowed a $1,300 standard deduction. The next $1,300 of any income is subject to Eric’s marginal tax rate (likely 10%). Income above $2,600 is taxed using a special set of rules based on your income tax rates (the “kiddie tax” rules). This option provides the maximum flexibility while removing the income from your parents’ high marginal tax bracket.

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Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

•

Your parents could buy tax-exempt bonds and accumulate the interest, which is excludible from gross income. However, the rate of return on the investment may be much lower than could be obtained with taxable options.

•

Your parents may give the $4,000 a year to you, and you could purchase Series EE bonds in your name and use the proceeds to pay Eric’s educational expenses. No tax will be due on the interest. This option would not be available if your parents purchased the bonds because the exemption is not available to taxpayers in your parents’ income class. That is, the potential exclusion would be completely phased out for your parents.

•

Your parents could invest the funds in Connecticut’s Qualified Tuition Program. This program provides a hedge against inflation in tuition cost but little or no other return on the investment. The earnings of the fund, including the tuition savings, will not be included in gross income provided the contribution and earnings are used for qualified education expenses.

If I can be of further assistance in helping you make this decision and explain the options to your parents, please call me. Sincerely yours, John J. Jones, CPA Partner 54. (LO 2) a. The savings bonds qualify as educational savings bonds. The savings bonds were issued to Chuck and Luane, who were at least 24 years of age (actually older), and the savings bonds were issued after 1989. Paying the tuition and fees ($8,000) for Susie, their dependent, qualifies as higher education expenses. The room and board of $4,000 does not qualify. Because the redemption amount ($12,000) exceeds the $8,000 of qualified higher education expenses, only part of the interest qualifies for exclusion treatment as follows: $5,000 × ($8,000 ÷ $12,000) = $3,333 Because their modified adjusted gross income (MAGI) of $149,600 exceeds the 2024 threshold amount of $145,200, part of the potential exclusion is phased out. MAGI Less: Threshold amount Excess over threshold amount

$149,600 (145,200) $ 4,400

The amount of the potential exclusion that is phased out is as follows: $3,333 × ($4,400 ÷ $30,000) = $489 Thus, Chuck and Luane can exclude $2,844 ($3,333 − $489) of the savings bond interest received and $2,156 ($5,000 − $2,844) must be included in their gross income. b. All of the $5,000 of savings bond interest must be included in Susie’s gross income. The educational savings bond exclusion under § 135 applies only if the savings bonds are issued to an individual who is at least age 24 at the time of issuance. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

55. (LO 2) a. All of the plan earnings during this period are excluded from gross income because the expectation is that the entire amount in the accounts will be used for higher education expenses. b. Neither Albert nor Kim reports gross income associated with the $7,500 because it is used for qualified higher education expenses. c. Neither Albert nor Kim will be required to include the 10% discount in gross income. d. Albert’s basis in the account is $20,000. So he must include $22,000 ($42,000 − $20,000) in his gross income. He is also subject to a 10% additional tax of $2,200, reported on Form 5329. Note that although Jim did not attend college, he could have used the funds for the costs of certain apprenticeship programs. 56. (LO 3) a. Orange Furniture must include $1,000 in gross income as the recovery of a prior deduction that produced a tax benefit. It should be noted that the original income in 2022 was taxed at 35%, the bad debt deduction reduced taxes at the 12% rate in 2023, and the recovery in 2024 would also be taxed at 35%. The timing of the income and deductions cost Orange (0.35 − 0.12) × $1,000 = $230. b. Marvin must include $800 of the refund in his gross income for 2024 because he received a tax benefit for the deduction in 2023. The other $700 of the refund is not included in his gross income because it did not produce a tax benefit. Marvin suffered an economic loss from the overpayment in 2023, when his marginal tax rate (12%) was lower than in the year of the recovery (35%) of the prior deduction, 2024. c. Barb must include $3,000 in her 2024 gross income, the amount of the reduction in taxable income from the medical expenses paid in 2023. The remainder of the amount received can be excluded as resulting from a personal physical injury. 57. (LO 2) a. When the debt is canceled, Vic’s debt will be canceled in consideration of his service to the estate. Therefore, the $25,000 debt cancellation must be included in Vic’s gross income when the uncle dies and Vic fulfills his obligation. b. Vic’s debt was not canceled. Rather, Vic transferred property in satisfaction of the debt, and Vic will have a $20,000 loss ($80,000 − $100,000 basis in the property). c. The $12,000 reduction in the debt is not included in Vic’s gross income because the debt reduction was made by the seller of the property. Vic must reduce his basis in the property by $12,000.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

TAX RETURN PROBLEMS 58. Gross income Salary ($150,000 + $43,800) Group term life insurance (Note 1) Interest income State tax refund (Note 2)

$193,800 300 500 –0– $194,600

Deductions for adjusted gross income Alimony paid (Note 3) Adjusted gross income Standard deduction (greater than itemized deductions) Taxable income

(15,000) $179,600 (27,700) $ 151,900

Tax on $151,900 (Note 4) Less: Tax withheld ($20,800 + $5,300) Net tax payable (or refund due) for 2023

$ 24,033 (26,100) ($ 2,067)

Completed tax forms for this problem are available on the Cengage Instructor Center. Notes (1)

Group term life insurance results in gross income for Alfred of $300 as follows: $300,000 − $50,000 $1,000

× $0.10 × 12 months = $300

(2)

Under the § 111 tax benefit rule, Alfred and Beulah do not include the $1,900 state tax refund in their gross income. They received no tax benefit from the deduction in 2022 because they claimed the standard deduction that year.

(3)

The $15,000 is deductible alimony. The $50,000 payment is a property settlement and is not deductible by Alfred.

(4)

The tax liability on taxable income of $151,900 is calculated using the 2023 Tax Rate Schedule for married taxpayers filing jointly (see Appendix A).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

59. Part 1—Tax Computation Salary Less: Foreign earned income exclusion (Note 1) Interest on Bahamian account (Note 2) State income tax refund (Note 3) Gross income (Note 4) Less: Deductions for adjusted gross income: Alimony paid AGI Less: Standard deduction (greater than itemized deductions) Taxable income

$140,000 (15,899) 2,300 1 ,200 $127,601 (6,600) $1 21,001 (29,200) $ 91,801

Tax (from 2024 Tax Rate Schedule for MFJ; Note 5) Less: Child and dependent tax credit (Note 6) Less: Withholding by employer Net tax payable (or refund due) for 2024

$ 1 2,2 10 (2,500) (1 0 ,750) ($ 1,040)

Notes (1)

Because Michele satisfies the 330 out of 366 day requirement, she qualifies for the foreign earned income exclusion for the 46 days in 2024 (January through February 15) she worked in Mexico. Her actual pay of $140,000 exceeded the limit on the exclusion. As a result, she is allowed to exclude only $15,899 [(46 ÷ 366) × $126,500]. Note that 2024 is a leap year.

(2)

The $2,300 interest on the Bahamian bank account is included in gross income. The $400 interest on the Montgomery County school bonds is excluded from gross income.

(3)

The state income tax refund of $1,200 is included in gross income under the tax benefit rule because the state income taxes were taken as an itemized deduction in 2023 and were less than the $10,000 SALT cap (and itemized deductions net of state taxes exceeded the 2023 standard deduction of $27,700); as a result, the couple received a tax benefit from the state income tax deduction in 2023.

(4)

The fair market value of $2,500 of the Applegate Corporation stock dividend is not included in gross income because no option was available for receiving cash.

(5)

The Albert’s tax must be determined in a two-step process. First, compute the tax that would apply to taxable income without the foreign earned income exclusion [$107,700 ($91,801 + $15,899)]; the tax on this amount is $13,800. Second, compute the tax on only the amount of the foreign earned income exclusion ($1,590; $15,899 × 10%). The tax on the foreign earned income exclusion ($1,590) is then subtracted from $13,800, yielding a tax of $12,210. Effectively, the tax on the income in excess of the foreign earned income exclusion is taxed at the marginal rate(s) that would apply without the exclusion.

(6)

Charlene (age 16 in 2024) will qualify for a $2,000 child tax credit; her parents’ modified AGI is below $400,000, so the credit is not subject to phaseout. Jordan is too old to qualify for the child tax credit. But because he meets the definition of a dependent, a $500 dependent tax credit is allowed.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

Part 2—Tax Planning SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 April 10, 2025 Mr. and Mrs. Martin S. Albert 512 Ferry Road Newport News, VA 23601 Dear Mr. and Mrs. Albert: You asked me to determine the after-tax effect of a $1,000 increase in your monthly mortgage payment as the result of buying another house. The $1,000 increase in your monthly mortgage payment will result in approximately a $700 monthly increase in mortgage interest and property tax deductions. As the payments are made on the mortgage, the interest portion will decrease, and the principal portion will increase over the next several years. Even with the additional mortgage interest and property tax expense, your itemized deductions will remain below your standard deduction ($29,200 in 2024). As a result, the additional expenses will not have any effect on your Federal income tax liability. If you have further questions, please contact me. Sincerely yours, John J. Jones, CPA Partner

RESEARCH PROBLEMS 1.

In Murphy v. United States, 2007–2 USTC ¶50,531, 100 AFTR 2d 2007–5075, 493 F.3d 170 (CA–DC), the appellate court noted that although the Sixteenth Amendment to the Constitution grants Congress the power to tax income, the Federal government is not limited to taxing only income. Thus, based on a long line of Court decisions, the Federal government has the right to tax a variety of transactions. Congress has indicated in § 104 that it intended to tax nonphysical personal injury awards. Thus, Murphy’s award was taxable. The same result holds true for Murray.

2. In Ltr.Rul. 201034012 (May 5, 2010), the IRS agreed that employees in similar circumstances (mandatory contributions to a fund used exclusively for postretirement benefits) could exclude such amounts from their gross income.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

3. Code § 61(a) defines gross income as “all income from whatever source derived . . . .” This suggests that the fair market value of the coupons ($900) would be included in Simon’s gross income. Further, C.I.R. v. Glenshaw Glass Co., 55–1 USTC ¶9308, 47 AFTR 162, 75 S.Ct. 473 holds that “clear accessions to wealth, clearly realized, and over which . . . taxpayers have complete dominion” are included in gross income. Thus, the fact that all of the coupons were not used does not affect the amount included in income. Moreover, the coupons do not meet the requirements to be excluded as a prize under § 74, as discussed in Chapter 4. 4. Based on Rev.Rul. 77–318, whether Aubrey may exclude the $12,000 from his gross income depends on the nature of the payments. According to the ruling, an individual who receives compensation from the Veterans Administration for injuries resulting from active service in the armed forces (i.e., disability payments) may exclude such payments from gross income. However, any payments received for civil service payments associated with such disability must be included in gross income. Aubrey’s payments are Social Security disability payments. Based on the ruling, it appears that Aubrey must include the $12,000 in his gross income. The Second Circuit Court of Appeals in Reimels affirmed the position taken by the IRS. The Social Security disability payments were made on account of the taxpayer’s inability to work rather than on account of the cause of his inability to work. That is, the Social Security benefits were wage-replacement benefits paid to compensate for the taxpayer’s inability to work and related economic loss rather than for the disability itself.

RESEARCH PROBLEMS 5 TO 8 These research problems require that students utilize online resources to research and answer the questions. As a result, solutions may vary among students and courses. You should determine the skill and experience levels of the students before assigning these problems, coaching where necessary. Encourage students to use reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax professionals, academics, think tanks, and political outlets to research their answers. 5. Students should find a table in the individual income tax return information that shows the number of returns and amount of tax-exempt interest claimed by individuals within various ranges of AGI. 6. John Deere & Company, in the job listing section of its website, provides information about benefits as a way to persuade applicants of the desirability of its workplace. Fortune 500 company websites might be the easiest places to locate this information. See, for example: •

deere.com/en/our-company/john-deere-careers/

•

boeing.com/careers/benefits

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

7. A state may exclude lottery winnings if they are from that state’s lottery. One likely rationale is to encourage sales of lottery tickets. 8. Student responses will vary. In general, students will find that the current versions of the AI tools often provide incomplete or incorrect answers. Evolution of the AI tools may lead to more complete and accurate results over time. During the development process for the 2025 edition, ChatGPT provided incomplete or incorrect answers to all of these questions. For Problem 28, ChatGPT provided independent answers for Ed and Ed’s widow. It correctly categorized the $10,000 as a gift (and excludible from income). But provided incorrect responses for all of the other items. For Problem 38, ChatGPT’s responses were incorrect. It indicated that all of the items were includible in gross income. And, it determined that Rex’s income from the wage continuation policy was $5,340 (the $4,500 of lost wages plus the $840 cost of the policy). For Problem 42, ChatGPT indicated that the $9,000 per month value of the house was includible in Tim’s gross income, along with the $385 per month parking (it did not identify the $315 allowable exclusion for qualified parking).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

CHECK FIGURES 21. 22. 23. 24. 25. 26. 27.a. 27.b. 28. 29.a. 29.b. 29.c. 29.d. 30.a. 30.b. 31.a. 31.b. 31.c. 31.d. 31.e. 32. 33.a. 33.b. 33.c. 34.a. 34.b. 35. 36.a. 36.b. 37.a. 37.b. 37.c. 37.d. 37.e.

$4,550. $117,519. $0. $0. $16,000. $13,500. $700. $0. $0 although the IRS may challenge exclusion of $12,000. Include in gross income. Include in gross income. $0. $3,500. $15,000 capital gain on stock sale; $0 gross income if “terminally ill” on insurance policy. $15,000 capital gain on stock sale; $20,000 ordinary income on life insurance policy. The salary of $50,000 is included in gross income. $3,000 as compensation. $10,000 as compensation. $15,000 as compensation. $0. Include $86,000 in gross income. Ray has $0 gross income on the receipt of the $800,000 life insurance proceeds. $16,000 of interest is included in gross income. $0 gain. Room and board of $6,000 is includible as is transportation of $1,200. Additional compensation to Willy’s father. $4,050 is includible in 2025. Leigh must include $80,000 in gross income. Yes. Include $25,000 in gross income. $150,000. $50,000. $50,000. $30,000. $300,000.

38. 41. 42. 43.a. 43.b. 43.c. 44. 46.a. 46.b. 46.c. 47.a. 47.b. 47.d. 48.a. 48.b. 48.c. 48.d. 48.e. 48.f. 49. 50. 51.a. 51.b. 51.c. 52. 54.a. 54.b. 55.a. 55.b. 55.c. 55.d. 56.a. 56.b. 56.c. 57.a. 57.b. 57.c. 58. 59.

$4,500. Include $0 in gross income. No gross income for home; $70 per month of gross income for parking. Include $10 per meal in gross income. Include $0 in gross income. Lodging excluded from gross income. Decrease in disposable income $15,012. $11,201; $12,072. $9,043; $9,185. $6,750; $6,750. $240. $760. Low end. Include $0. Exclusion allowed for $3,780; include $600. Exclusion allowed. Exclusion allowed. Exclusion allowed. No exclusion for Polly; plan is discriminatory. $201,036 (2024); $173,500 (2025). $1,400. $1,000. $0 gross income. No current deduction; $1,000 income for shares received in lieu of cash. Greater after-tax yield on California bond. Exclude $2,844. Include $5,000 for Susie. $0. $0. $0. $22,000. $1,000. $800. $3,000. $25,000 gross income. $20,000 loss. Reduce basis by $12,000. Refund due for 2023 $2,067. Refund due for 2024 $1,040.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

SOLUTIONS TO ETHICS & EQUITY FEATURES Should the Terminally Ill Pay Social Security Taxes? (p. 5-6). The critics have a good point if the Social Security system is viewed as a retirement savings plan. However, the Social Security system often operates as a taxing component and a benefits component. Tax Treatment of Damages Not Related to Physical Personal Injury (p. 5-9). Fairness is in the “eye of the beholder.” A taxpayer receiving a compensatory award or settlement for physical personal injury or sickness obviously believes that such amounts should be excluded from gross income. In fact, such a taxpayer would also like to exclude from gross income any amount received for punitive damages. On the other hand, a taxpayer who receives an award or a settlement in a sex discrimination case or an age discrimination case surely would like to exclude the amount from gross income. Likely, such a taxpayer feels unfairly treated by the tax law. Classifying the Amount of the Claim (p. 5-10). If Lee pursued his original claim, the most he could expect to receive would be $200,000. Because the $100,000 punitive damages would be taxable, his after-tax amount will be less. Assuming that Lee’s marginal tax rate is 22%, his after-tax damages would be $200,000 − 0.22($100,000) = $178,000. By accepting the $150,000, Lee avoids the risk of a court’s smaller award and additional expenses of pursuing his claim. Moreover, the $150,000 would be nontaxable. However, should Lee claim more as compensation for his physical injury than he actually suffered? Realistically, Lee might resolve this ethical issue by reasoning that measuring physical personal damages is not an exact science when future consequences are unknown; therefore, perhaps the $150,000 is a reasonable estimate of his actual injuries. Fringe Benefits (p. 5-20). Given the goal of Congress to make the employer’s deduction for employee compensation more similar to the amount of the employee’s compensation, either approach would work―disallowing a deduction to the employer for the fringe benefits or making them taxable to the employee. If they are taxable to the employee, additional payroll taxes also would be owed by both the employee and employer. Assuming that the employer is a corporation subject to a 21% Federal income tax rate, the income tax effect of either approach would be similar because most individuals are in the 22% bracket or lower. Because the TCJA of 2017 lowered the corporate tax rate to 21% from a high of 35%, Congress may have believed that denying the deduction to the employer was the better approach. A desire not to increase taxes for voters also may have factored into the decision. The approach taken by Congress meant that, for equity purposes, qualified transportation fringe (QTF) benefits provided by a tax-exempt employer had to have similar tax consequences. To this end, the TCJA imposed a 21% tax on the QTF benefits provided by such employers [§ 512(a)(7)]. Due to later opposition by these employers and others, Congress repealed this tax on tax-exempt employers retroactively back to 2018 [P.L. 116–94 (12/20/19)].

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

SOLUTIONS TO BECKER CPA REVIEW QUESTIONS 1.

Choice “b” is correct. The $5,000 earnings from the part-time job is taxable because this is compensation. The $25,000 scholarship is not taxable. Scholarships used for tuition, fees, and books are not included in gross income. Choice “a” is incorrect. The $25,000 scholarship is not taxable. Scholarships used for tuition, fees, and books are not included in gross income, but compensation received is taxable income. Choice “c” is incorrect. The $5,000 earnings from the part-time job is taxable because this is compensation. The $25,000 scholarship is not taxable since it is used to pay qualifying expenses. Scholarships used for tuition, fees, and books are not included in gross income. Choice “d” is incorrect. Although the $25,000 scholarship may be excluded from income, the $5,000 earnings from the part-time job is taxable compensation.

2. Choice “c” is correct. Amounts received as compensation for services ($6,000) are taxable. In addition, the amount of the scholarship not used for qualified expenditures is taxable ($1,500 for room and board) for a total taxable amount of $7,500. Rule: Scholarships and fellowships not used to pay for qualified expenditures (tuition, fees, books) are taxable income to the recipient. Choice “a” is incorrect, as it ignores both items that are taxable. Choice “b” is incorrect, as it does not consider the $1,500 of the scholarship not used for qualified expenditures. Choice “d” is incorrect. Scholarships used to pay for qualified expenditures to a degree-seeking student are excludible from gross income. This answer identifies the total scholarship received and compensation for teaching as taxable. 3. Choice “c” is correct. The $2,000 trip is considered an award and is included in Linda’s gross income. Choice “a” is incorrect. Premiums paid by an employer on up to $50,000 of coverage for an employee are excludible from gross income. Choice “b” is incorrect. Up to $5,250 of payments made by an employer on behalf of an employee’s educational expenses may be excluded from gross income. The exclusion applies to both undergraduate and graduate level education. Choice “d” is incorrect. The value of employer-provided parking up to $280 per month may be excluded by an employee (assuming 2022 rules apply). 4. Choice “a” is correct. $215,000 (the amount received for disability pay and punitive damages) is taxable. The $15,000 disability pay is taxable because the insurance was paid by Kim’s employer as a nontaxable fringe benefit. If Kim had paid the disability insurance premiums after tax, then the benefits received would not be included in gross income. The $200,000 received for punitive damages is fully taxable. The $5,000 reimbursement for medical expenses paid by Kim and the health insurance premiums

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

are not included in gross income. The $10,000 received for damages for personal physical injury is also not taxable. Choices “b,” “c,” and “d” are incorrect based on the above explanation. 5. Choice “b” is correct. Interest on municipal bonds (bonds issued by state or local governments) is excluded from gross income. Therefore, the city of Atlanta and State of Georgia bond interest is not taxable. The U.S. Treasury and Row Corporation bond interest is taxable. The Ellis Company stock dividend is also taxable. Choices “a” and “c” are incorrect. Interest on municipal bonds (bonds issued by state or local governments) is excluded from gross income. Therefore, the city of Atlanta and State of Georgia bond interest is not taxable. Choice “d” is incorrect. Although interest on municipal bonds (bonds issued by state or local governments) is excluded from gross income, income from interest on U.S. Treasury bonds and interest and dividends from corporations are included in taxable income. 6. Choice “c” is correct. $1,350 is included in Elizabeth’s gross income. The U.S. Treasury bond certificate interest ($500) plus the interest on the state tax refund ($200) plus the corporate bond interest ($600) plus the amount received for opening a new savings account ($50) equals $1,350. Interest on obligations of a possession of the United States, such as Puerto Rico, is tax-exempt. Choice “a” is incorrect. Interest on U.S. Treasury bonds and state tax refunds are taxable unless specifically excluded by law. Choice “b” is incorrect. Although interest on state and municipal bonds is not taxable, interest on a state tax refund is included in taxable income. Choice “d” is incorrect. Interest on obligations of a possession of the United States, such as Puerto Rico, is tax-exempt. 7. Choice “b” is correct. Stephen should contribute the maximum amount of $4,850 from his salary to an HSA and have the $4,000 of medical expenses paid from the HSA. Stephen can contribute up to $4,850 of his salary to an HSA in the current year ($3,850 2023 individual limit + $1,000 additional contribution for age 55 or older), which reduces his taxable gross income by $4,850. The payment of his $2,200 in medical expenses from the HSA is not included in his taxable gross income. HSA funds that are not spent continue to accumulate tax-free, so the $2,650 balance in his HSA at the end of the current year ($4,850 contribution – $2,200 medical expenses paid) is rolled over to future years. Choice “a” is incorrect. Stephen can only contribute up to a maximum of $3,050 (2023) of his salary to a health care FSA, which reduces his taxable gross income by $3,050. The payment of his $2,200 in medical expenses from the FSA is not included in his taxable gross income. However, unlike an HSA, an FSA is typically “use it or lose it.” An employee must use the money in the FSA within the plan year or lose the funds unless the employer offers either a 2.5-month grace period to spend the funds for qualified expenses or a carryover of up to $610 (2023) to use in the following year. Although the amount Stephen can contribute is enough to cover his expected $2,200 of medical expenses, Stephen could lose part or all of the remaining $850 ($3,050 – $2,200) of his

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

current year contribution unless he has additional qualifying medical expenses next year and his employer provides either a carryover (up to $610) or a 2.5-month grace period to spend the funds. Choice “c” is incorrect. Stephen’s contribution of $2,200 to an HSA in the current year reduces his taxable gross income by $2,200, and the payment of his $2,200 in medical expenses from the HSA is not included in his taxable gross income. However, Stephen could reduce his current taxable gross income by another $2,650 if he contributes the maximum allowable amount to his HSA ($4,850 – $2,200 = $2,650). The additional $2,650 in the HSA is available for future qualifying medical expenses but will continue to accumulate tax-free even if it is not spent on qualifying medical expenses. Choice “d” is incorrect. Stephen cannot deduct the medical expenses on his individual Federal income tax return. Medical expenses are only deductible as an itemized deduction, and only to the extent that they exceed 7.5% of AGI. The facts provide that Stephen does not itemize deductions. Even if Stephen were to itemize deductions, his unreimbursed medical expenses would not be deductible because they do not exceed the 7.5% of AGI floor of $4,500 ($60,000 AGI × 7.5%). 8. Choice “c” is correct. Kirsten lives and works in Canada for the entire year, so she meets both the bona fide residence test and physical presence test, although she is only required to satisfy one of the tests to qualify for the foreign-earned income exclusion. Both her $115,000 salary and $20,000 bonus qualify as foreign-earned income, so her total income earned while residing in a foreign country is $135,000. She is allowed to exclude $120,000 (2023) of her $135,000 foreign-earned income for the current year. Choice “a” is incorrect. Kirsten is allowed to exclude up to $120,000 (2023) of her foreign-earned income. Choice “b” is incorrect. Kirsten is allowed to exclude up to $120,000 of her salary and bonus, not just her $115,000 salary. Choice “d” is incorrect. Kirsten can only exclude $120,000 of her total foreign-earned income of $135,000. 9. Choice “c” is correct. Interest on Series EE Savings Bonds is tax-exempt when it is used to pay for higher education for the taxpayer, a spouse, or dependents. The amount paid for higher education is reduced by any tax free-scholarships received. Because Sue’s $40,000 AGI is under the phase-out threshold, the interest may be excluded. Choice “a” is incorrect. The $10,000 in tax-free scholarships reduces the $10,000 of higher education costs to zero. Therefore, Sue’s $10,000 in U.S. Series EE Savings Bond interest is taxable. Choice “b” is incorrect. There is no exclusion for U.S. Series EE Savings Bond interest for those using the married filing separately status. Choice “d” is incorrect. Sue’s AGI of $240,000 is above the phase-out threshold for U.S. Series EE Savings Bond interest exclusion.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 5: Gross Income Exclusions

10. Choice “d” is correct. All five statements are true in regard to the exclusion of U.S. Series EE savings bond interest. Choices “a,” “b,” and “c” are incorrect, based on the above explanation.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

Solution and Answer Guide

YOUNG, PERSELLIN, NELLEN, MALONEY, CUCCIA, LASSAR, CRIPE, SWFT COMPREHENSIVE VOLUME 2025, 9780357988817; CHAPTER 6: DEDUCTIONS AND LOSSES: IN GENERAL

TABLE OF CONTENTS Discussion Questions...........................................................................................................1 Computational Exercises ................................................................................................. 5 Problems ............................................................................................................................. 7 Tax Return Problems .........................................................................................................17 Research Problems ........................................................................................................... 22 Check Figures.................................................................................................................... 27 Solutions To Ethics & Equity Features ............................................................................ 28 Solutions To Becker CPA Review Questions ................................................................... 29

DISCUSSION QUESTIONS 1.

(LO 1) Although the Code provides an all-inclusive definition of income, deductions must be specifically provided for in the Code in order to be permitted.

2. (LO 1) Yes. The deduction for the traditional IRA contribution will reduce his taxable income. Because the contribution is a deduction for AGI, it reduces his taxable income but has no impact on his itemized deductions. Therefore, his standard deduction will still exceed his itemized deductions, and he will continue to use the standard deduction. 3. (LO 1) a. Not deductible. b. Deduction from AGI. c. Deduction from AGI (subject to 7.5%-of-AGI floor). d. Not deductible. The alimony payments relate to a divorce agreement signed after 2018. e. Deduction for AGI. f.

Deduction for AGI.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

4. (LO 1) a. Deduction for AGI, if not designated as Roth contributions. b. Not deductible. c. Not deductible from 2018 through 2025 since the payment is not reimbursed by the employer. This is an employee business expense (and a miscellaneous itemized deduction). d. $2,000 deduction from AGI. The $1,000 principal payment is not deductible. e. Moving expenses are not deductible (an exception is provided for military personnel). f.

Deduction from AGI. From 2018 through 2025, the deduction for personal state and local taxes is limited to a total of $10,000. So $1,000 of the taxes is not deductible.

5. (LO 1) Investment expenses associated with rental property or royalty property are deductible for AGI. Investment interest expense is deductible from AGI (but subject to a limitation based on net investment income). All other investment expenses are miscellaneous itemized deductions (and not deductible from 2018 through 2025). Susan evidently has invested in rental or royalty property, whereas Larry has invested in other investment property. 6. (LO 1) Nanette is eligible to deduct the charitable contributions of $800 and the personal property taxes of $240 as itemized deductions (deductions from AGI). However, because the standard deduction for 2024 of $14,600 is greater than her itemized deductions of $1,040, she should claim the standard deduction. In addition, she is allowed the $225 under the teacher’s professional development and supplies provision as a deduction for AGI. 7. (LO 1) The statutory language of the Code refers to reasonableness only with respect to salaries and other compensation. However, the courts have held that for any business expense to be ordinary and necessary, it also must be reasonable in amount. 8. (LO 1) The tax consequences to Dave for the residence and the business portions are different. The casualty loss on the residence is a personal loss that is deducted from AGI as an itemized deduction (but only if the casualty relates to a Federally declared disaster area). If this is not the case, then the personal casualty loss is not deductible. No such limitations relate to the casualty loss on the business portion; this loss is a business loss, which is a deduction for AGI. 9. (LO 1) Rental income and expenses are reported on Schedule E (Supplemental Income or Loss) of Form 1040. 10. (LO 2) Cash basis taxpayers can deduct an expense only when it has been paid with cash or other property. Borrowing the money to pay the expense (or charging it on a bank credit card) constitutes actual payment. However, actual payment does not ensure a current deduction. For example, capital expenditures must be capitalized. Subsequently, the expenditure may be amortized, depleted, or depreciated. Except in certain circumstances, prepaid items currently cannot be deducted.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

11. (LO 2) a. It is doubtful that Aubry can deduct the $65,000 of supplies in 2024 because he was motivated by tax considerations (i.e., to manipulate income). Further, given Aubry’s expectation that it will take more than a year to use up the supplies, the “12-month rule” could also apply and require Aubry to defer any deduction until the supplies are used. b. If Aubry bought the supplies at a discount, he would be motivated by business reasons other than tax reduction. However, the “12-month rule” would still apply. See also Zaninovich v. Comm., 80–1 USTC ¶9342, 45 AFTR 2d 1442, 616 F.2d 429 (CA-9). 12. (LO 3) No. Clear cannot deduct the fines because they are payments in violation of traffic laws. 13. (LO 3) The two issues involved are whether the payment should be made and, if made, whether it is deductible. If the payment was made to the representatives of the U.S. government, it would be a bribe. It not only would be nondeductible but also could result in criminal charges. If the payment is made to a representative of a foreign company, it is possible that it is an accepted trade practice in that country. In this case, because the payment would not violate the U.S. Foreign Corrupt Practices Act of 1977, it would be deductible. If the payment were to a foreign government official, it would violate the U.S. Corrupt Practices Act of 1977 and not be deductible. 14. (LO 3) No. Legal fees incurred in connection with a criminal defense are generally deductible only if the crime is associated with the taxpayer’s trade or business or income-producing activity. Because Stuart does not satisfy this requirement, the attorney’s fee is not deductible. 15. (LO 3) Even though this is an illegal business, expenditures that are ordinary, necessary, and reasonable are deductible. The bribes paid to city employees (a.) and kickbacks to police (d.) are not deductible because they violate public policy. All of the other items are deductible (b., c., e., f., g., and h.). 16. (LO 3) No. A deduction is not permitted for political contributions. 17. (LO 3) Lobbying expenses generally are not deductible. Therefore, if Melissa pays the $1,500 to a professional lobbyist, the payment is not deductible. However, a de minimis exception provides that in-house lobbying expenditures not exceeding $2,000 per year can be deducted. Thus, if Melissa spends the $1,500 on in-house lobbying expenditures, she can deduct this amount. Note that if the in-house expenditures had exceeded $2,000, none of the in-house expenditures could have been deducted. 18. (LO 3) The compensation must be reasonable; this limitation is most often an issue for closely held corporations. For publicly traded corporations, the deduction is limited to $1,000,000 per covered employee. There are two groups of covered employees. The first group includes the chief executive officer (CEO), the chief financial officer (CFO), the three other most highly compensated executives and anyone serving as CEO or CFO during the year. This group of employees is subject to these rules permanently. For taxable years beginning after December 31, 2026, a second group of employees is subject to the $1,000,000

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

limitation: the top five compensated employees that are not in the first group. This second group of employees is subject to the limitation on a year-to-year basis (i.e., they are not permanently subject to this rule). Before 2018, the $1,000,000 limit excluded commissions and performance-based compensation. Contracts in place on November 2, 2017, are grandfathered into pre-2018 law as long as there are no material changes to the contract. 19. (LO 3) a. Apparently the business being investigated by Blaze was a restaurant. Because Blaze is already in the restaurant business, he can deduct all of the investigation expenses of $7,000 whether or not he acquires a new business. b. Evidently the business being investigated was not a restaurant, and Blaze did not acquire the business. Consequently, he is not allowed any deduction for the expenses. c. The business in Columbus that Blaze investigated was not a restaurant, but Blaze did acquire the business. Therefore, he can take a limited deduction of $5,000 and amortize the balance as startup costs over a 180-month period. 20. (LO 3) In prior years, the beach house has been classified as a rental property because the personal use (exactly 14 days) did not exceed the greater of 14 days or 10% of rental days (200 × 10% = 20 days). Thus, if the total available deductions exceeded the rental income, the loss could be deducted on Karen and Andy’s tax return. If Sarah is permitted to use the beach house for 7 days, the total personal use days of 21 will exceed the statutory limit of 20 days (i.e., 10% of rental days of 200). In this case, the deductions are permitted only to the extent of the rental income. What needs to be determined are whether the deductions do exceed the rental income and whether Sarah wants to use it for a full seven days. 21. (LO 3) Hank can deduct property taxes and mortgage interest from January 1 to March 1 as an itemized deduction from AGI. The home was his personal residence during that period. For the rest of the year, from March 1 through December 31, he can deduct property taxes, mortgage interest, depreciation, and all other expenses for AGI as rental expenses. The “qualified rental period” requirements have been met. He has converted his personal residence into rental property, and no allocation of expenses need be made even if there is a rental loss (see footnote 50). 22. (LO 3) a. For Ray to deduct the interest, he needs to make the payment to the mortgage company. Thus, Sahar could give the money to Ray so that Ray pays the mortgage company. b. If Sahar pays the mortgage company directly, Sahar cannot deduct the interest because it is not his obligation. Ray may not be permitted the deduction because he did not make the payment. However, the Tax Court allowed a deduction when a mother made payments for medical expenses and property taxes directly to the medical services provider and the city government, respectively, on behalf of her daughter (Judith F. Lang, 100 TCM 603, T.C.Memo. 2010–286). The Tax Court deemed the payments a gift to the daughter, who then made deemed payments to

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

satisfy her obligations. By relying on this case, Ray might be able to claim a deduction for the mortgage interest. c. The obligation is that of Ray and not Sahar. Thus, Sahar is not permitted to deduct the interest even if he makes the payment directly to the mortgage company. 23. (LO 3) The tax issue is whether Ella will be able to deduct the loss on the sale of the stock. If the transferee is a related party under § 267, the realized loss is disallowed. Otherwise, the realized loss is recognized. The gift to the other relative has no effect on the sales transaction. Although no income tax consequences result, the imposition of a Federal gift tax should be considered. Also, the gift loss basis rule will preclude the donee relative from any tax benefit associated with the pre-gift decline in the stock’s fair market value. (See Chapter 13 for the gift basis rules.) 24. (LO 3) a. Although Jarret receives interest payments of $3,800, this entire amount is excluded from his gross income. Interest on municipal bonds is tax-exempt. b. None of Jarret’s interest payments of $4,900 on the loan can be deducted. The proceeds of the loan were used to purchase tax-exempt bonds. Consequently, the interest expense deduction is disallowed. Likewise, none of the principal payments of $1,100 can be deducted because this is merely the payment of a liability. 25. (LO 3) If Blair Corporation is a publicly traded company, only $1,000,000 of the compensation is deductible (its CEO is a covered employee, and the CEO’s compensation plan was created or modified after November 2, 2017). If Blair is not publicly traded, the entire compensation is deductible, provided it is reasonable under the circumstances.

COMPUTATIONAL EXERCISES 26. (LO 2) a. The entire $8,400 is deductible since the benefit from the payment will be completely received by the end of 2025. b. Since the benefit from the payment will not be completely received by the end of 2025 (the end of the tax year following the year of payment), the only payments deductible in 2024 are for the benefits received in 2024 (nine months; $8,400 × 9/24 = $3,150). 27. (LO 2) a. Under the cash method, Falcon can deduct only the salaries paid of $500,000. The $45,000 of unpaid salaries can be deducted when paid next year. b. Under the accrual method, the $500,000 is deductible because both the all events test and the economic performance test are satisfied. These tests also are satisfied for the $45,000 of unpaid and accrued salaries. Consequently, Falcon can deduct the $45,000 for a total deduction of $545,000 ($500,000 + $45,000).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

28. (LO 2) Meghan must capitalize and amortize the $120,000 paid in February 2024 for rent from February 2024 through July 2025. She does not qualify under the “12-month rule” for prepaid expenses because the period for which prepayments have been made extends beyond the earlier of (1) January 31, 2025 (12 months after the first date on which the taxpayer realized benefits), or (2) December 31, 2025 (the end of the following tax year). Her 2024 deductible rent expense is $73,333 ($6,666.67 per month × 11 months; rounded). 29. (LO 3) All ordinary and necessary expenses incurred in operating an illegal business are deductible. Expenses that are in violation of public policy are not deductible (bribes and illegal kickbacks). All other expenses, which total $291,400, are deductible. 30. (LO 3) a. $25,000 × 40% = $10,000. b. $0; if in-house lobbying expenditures exceed $2,000, none of the in-house expenditures can be deducted. 31. (LO 3) Since Stanford is not in the restaurant business and he does not acquire the restaurant, the $28,000 is not deductible. He cannot deduct all of the $51,000 related to the investigation of the bakery since he is not in that trade or business already. Since he did purchase the bakery, the maximum deduction (before amortization) of the $51,000 is $5,000. The $5,000 deduction is reduced dollar for dollar for those expenses in excess of $50,000. $51,000 – $50,000 = $1,000 reduction. $5,000 – $1,000 = $4,000 deduction. The remaining expenses of $47,000 ($51,000 – $4,000) can be amortized over 180 months beginning with the month business begins, which is November. $47,000 ÷ 180 months = $261 per month. $261 × 2 months = $522. The total deduction is $4,522 ($4,000 + $522). 32. (LO 3) Tobias can deduct only the interest expense attributable to taxable income. The interest attributable to the municipal interest income is not deductible. Thus, only $17,500 ($350,000 ÷ $400,000 × $20,000) is deductible, subject to the net investment income limitation (discussed in Chapter 11).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

PROBLEMS 33. (LO 1) a. Because Amos pays the expenses related to his tax law practice, he can claim them in calculating AGI. The expenses reduce his AGI by $4,850, determined as follows: Conference registration ($900 + $900) Airline tickets ($1,200 + $700) Taxi fares Lodging ($750 + $300)

$1,800 1,900 100 1,050 $4,850

b. The answer in part a. for Amos would not change. These expenses are associated with his business as a tax attorney. 34. (LO 1) a. Gross income: Salary income Net rent Dividend income Deductions for AGI: Alimony paid (divorce finalized in March 2022) Contribution to traditional IRA Loss on sale of real estate Adjusted gross income b. Itemized deductions: Mortgage interest on residence Property tax on residence Contribution to church State income tax Medical expenses [$3,250 − ($86,500 × 7.5%)] Total itemized deductions

$86,000 6,000 3,500 $

–0– 7,000 2,000

$95,500

(9,000) $86,500

$1 1 ,900 3,200 2,1 0 0 2,800 –0– $20,000

Because the standard deduction for 2024 ($14,600) is less than Daniel’s itemized deductions ($20,000), Daniel should itemize his deductions from AGI. The Federal income tax of $9,700 is not deductible.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

35. (LO 1)

Gross income Contribution to IRA AGI Itemized deductions: Charitable contribution State income taxes Medical expenses [$6,000 − (7.5% × AGI)] Casualty loss [($9,500 − $100) − (10% × AGI)] Total itemized deductions

With IRA Contribution $60,000 (5,000) $55,000

Without IRA Contribution $60,000 (–0–) $60,000

$ 6,000 4,000 1,875 3,900 $15,775

$ 6,000 4,000 1,500 3,400 $14,900

The $5,000 traditional IRA contribution would increase María’s itemized deductions by $875 ($15,775 − $14,900). As a result, the $5,000 IRA contribution reduces her taxable income by $5,875 (the lower AGI increases the deduction for medical expenses and the casualty loss deduction). 36. (LO 1) Faith can deduct the following losses: Loss on sale of Yellow, Inc. stock Theft loss of uninsured business use car Loss on sale of City of Newburyport bonds Deductible loss

$1,600 1 ,500 900 $4,000

Neither the $8,000 loss on the sale of Faith’s personal use car nor the $10,000 loss on the sale of her personal residence is deductible because these assets are personal use assets. 37. (LO 1) a. Suzanne’s QBI deduction is $30,000 ($150,000 × 20%). The W–2 wages and qualified property limitation do not apply because Suzanne’s taxable income before the QBI deduction is less than $191,950. b. Suzanne’s taxable income before the QBI deduction exceeds $241,950. As a result, the W–2 wages and qualified property limitation must be included. As a result, Suzanne’s QBI deduction is $45,000, the lower of: 

$50,000 (20% × $250,000).



$45,000 (50% × W–2 wages of $90,000).

38. (LO 2) a. Gross receipts Less: Coliseum rental Food (cost of goods sold) Souvenirs (cost of goods sold) Performers Net income for 2024

$300,000 $ 25,000 30,000 60,000 100,000

(215,000) $ 85,000

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

Because Duck is an accrual basis taxpayer, it may accrue and deduct in 2024 the costs of the performers of $100,000 even though it is not paid until January 5, 2025 (i.e., the economic performance test is satisfied). However, the cleaning cost of $10,000 may not be deducted until 2025 when the services are performed (i.e., at that time, the economic performance test is satisfied). b. In 2024 and 2025, a $100,000 deduction produces a tax savings of $21,000 to Duck ($100,000 × 21%). But the tax savings in 2025 is coming one year later. The present value of the 2025 tax savings is $21,000 × 0.9524 (from Table E-2) = $20,000. The cost of the deferral to Duck is $1,000 ($21,000 − $20,000). 39. (LO 3) Only the $500 paid to the attorney to draft the lease is deductible by Fynn. This expense is an ordinary and necessary expense incurred in connection with rental property held for the production of income. The tickets and the related legal expenses are not deductible because they are personal in nature. Even if related to the conduct of a trade or business or the production of income, they are disallowed as a deduction because they violate public policy. Both the $1,000 payment for negotiating a reduction in child support payments and the $2,500 paid related to the alimony payment are personal in nature and not deductible. 40. (LO 3) a. The effect of the illegal gambling business on Trevor’s AGI is as follows: Gross income Deductible expenses: Salaries Payouts to winners Increase in AGI

$ 52,000 $ 8,000 29,000

(37,000) $ 15,000

The bribe to police of $7,500 is not deductible because this expense violates public policy. Trevor also must include the tip income of $16,000 in his gross income. As a result, the total impact on Trevor’s AGI is $31,000 ($15,000 + $16,000). b. Trevor’s taxable income also increases by $31,000 ($15,000 + $16,000). 41. (LO 3, 4)

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040

September 16, 2024 Ms. Angela Riddle, Chairperson Board of Directors Ascend, Inc. 150 Erieview Tower Cleveland, OH 44106 Dear Ms. Riddle: I am responding to your inquiry regarding the current compensation plan for Ascend’s president. The current plan has been in place since 2017. It provides for a base salary of $1,000,000 plus a performance-based bonus that is projected to be $1,200,000 in 2024, resulting in projected total compensation of $2,200,000 in 2024. I understand that the Board is considering revising the president’s compensation plan.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

In general, any salary paid to the president in excess of $1,000,000 is deemed excessive executive compensation (and not deductible). Before 2018, compensation earned under a performance-based compensation option was not subject to this limitation. Since 2017, Ascend has been able to deduct both the $1,000,000 base compensation and the additional performance-based bonus. In 2024, we project Ascend will deduct $2,200,000 in total compensation paid to the president. Beginning in 2018, the $1,000,000 limit on deductibility of executive compensation includes base pay, commissions, and performance-based compensation unless these amounts were part of a contract as of November 2, 2017, and there have been no material modifications to the contract. Since the president’s contract was in place as of November 2, 2017, and no material changes have been made to the contract, Ascend will be able to deduct all of the compensation paid to the president in 2023 and 2024. I recommend that you not make any changes to the president’s performance-based compensation contract. Doing so could be a material modification that would make the contract subject to the new provisions disallowing deductions for all compensation paid to the president in excess of $1,000,000. If, in the future, modifications need to be made to her contract, please consult with us at that time so that we can structure the changes in the most tax-efficient manner. Please let me know if you have any questions. Sincerely, Vijay Singh, CPA 42. (LO 3) Even though Henrietta decides not to pursue the expansion of her hotel chain into another city, the investigation expenses of $35,000 are deductible in the current year. Because Henrietta is in the hotel business, all investigation expenses associated with the hotel business are deductible in the year paid or incurred. Because Henrietta was not in the restaurant business, she can deduct only part of these investigation expenses. Of the $53,000, an amount of $2,000 [$5,000 − $3,000 (reduction for excess over $50,000)] can be expensed immediately. The balance of $51,000 ($53,000 − $2,000) is amortized over a period of 180 months at the rate of $283.33 per month ($51,000 ÷ 180) commencing in September (the month the business is started). Consequently, the total deduction for the year is $35,000 for the hotel investigation + $3,133.32 [$2,000 + ($283.33 × 4 months)] for the restaurant investment, or a total of $38,133 (rounded). 43. (LO 3) a. He can deduct $52,000. b. He can deduct $52,000. c. None of Terry’s expenses are deductible. d. Terry can immediately expense $3,000 and amortize the $49,000 balance ($52,000 − $3,000) over a period of 180 months beginning in October (the month the business is started). The deduction for 2024 is $3,817 [$3,000 + $816.67 ($49,000 ÷ 180 × 3 months); rounded].

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

44. (LO 3) a. Jamari’s business decreases his AGI by $1,940. Revenue Less: Depreciation on car Operating expenses of car Rent Wages Amortization Net income (loss)

$ 20,000 $3,960 3,1 0 0 6,000 8,200 680

(21,940) ($ 1,940)

The decline in the value of the land of $5,200 has no immediate tax consequence. b. If the activity is a hobby, the cash expenses, the depreciation, and the amortization are miscellaneous itemized deductions (and not deductible from 2018 through 2025). The revenues of $20,000 are reported on Schedule 1 (Form 1040) as Other Income. 45. (LO 3) Alex must report the $18,000 as revenues. All of the property taxes of $3,000 can be deducted as an itemized deduction (subject to the $10,000 limit on state and local taxes); these deductions would be allowed even if there was no revenue from the hobby. The remaining expenses total $16,250, of which only $15,000 ($18,000 hobby revenue − $3,000 property taxes) would be deductible. However, these expenses are classified as miscellaneous itemized deductions (and are not deductible from 2018 through 2025). 46. (LO 3) a. The vacation home is classified as primarily personal because it was rented for fewer than 15 days during the year. Since Piper can exclude the $2,500 of rent income, the vacation home transactions have no effect on her AGI. b. The only expenses that Piper can deduct are those she normally would deduct as itemized deductions. This includes the following: Mortgage interest Property tax Total

$10,000 1,500 $11,500

Piper cannot deduct any of the utilities, insurance, and maintenance expenses or the depreciation. None of the expenses are deductible for AGI. 47. (LO 3) Because the house was rented for fewer than 15 days, the rental income of $5,000 is excluded from Adelene’s gross income. The only expenses that can be deducted in this case are the real property taxes of $3,800 and the mortgage interest of $7,500. These expenses are classified as itemized deductions (i.e., deductions from AGI). Therefore, there is no effect on AGI.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

48. (LO 3) a. Gross income Deduct: Taxes and interest (30/365 × $11,500) Remainder to apply to rental operating expenses and depreciation Utilities and repairs [30/50 × ($2,400 + $1,000)] Remainder Depreciation (30/50 × $7,500 = $4,500, limited to remainder) Net rental income

$ 7,000 (945) $ 6,055 (2,040) $ 4,015 (4,015) $ –0–

She can itemize $10,555 of property taxes and mortgage interest ($11,500 total less $945 allocated to rental). Thus, under the court’s approach, Anna has no net rental income and has an itemized deduction of $10,555. The roof replacement of $12,000 is a capital expenditure, and the related depreciation is included in the $7,500 of depreciation. The $485 ($4,500 − $4,015) of rental depreciation not deductible in the current year is carried forward to next year. b. Gross income Deduct: Taxes and interest (30/50 × $11,500) Remainder to apply to rental operating expenses and depreciation Utilities and repairs [30/50 × ($2,400 + $1,000) = $2,040, but limited to remainder] Net rental income

$7,000 (6,900) $ 100 (100) $ –0–

Anna can deduct the remaining taxes and interest of $4,600 ($11,500 less rental allocation of $6,900) as itemized deductions. Under the IRS’s approach, she has no net rental income and has an itemized deduction of $4,600. The rental expenses not deductible in the current year are carried forward to next year. 49. (LO 3) Because Anna used it for fewer than 15 days, it is classified as rental property. Percentage of use Gross income Expenses: Interest and taxes ($9,000 + $2,500) Utilities and repairs ($2,400 + $1,000) Depreciation ($7,500) Total expenses Net income (loss)

Rental 87% $ 7,000

Personal 13% $ –0–

$10,005 2,958 6,525 $19,488 ($12,488)

$1,495 442 975 $2,912 $ –0–

Anna could deduct $325 ($2,500 × 13%) of property taxes as itemized deductions and take a rental loss deduction for AGI of $12,488, subject to the passive loss limitations (discussed in Chapter 11). The mortgage interest of $1,170 ($9,000 × 13%) is not deductible as an itemized deduction because it is not qualified residence interest. The roof replacement of $12,000 is a capital expenditure, and the related depreciation is included in the depreciation of $7,500.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

50. (LO 1, 3) Income (Note 1): Salary Dividend Rental of vacation home (Note 2) Adjusted gross income Itemized deductions: State income tax (Note 3) Property tax on home Interest on home mortgage Interest and property tax on vacation home (Note 2) Charitable contributions Tax return preparation fee (Note 4) Taxable income

$73,000 400 –0– $73,400 $ 3,300 2,200 8,400 4,893 1,10 0 –0–

(19,893) $53,507

Notes (1) The municipal bond interest of $2,000 is excludible from gross income, and the interest expense of $3,100 on the loan to buy municipal bonds is not deductible. (2) Rental income Less: Taxes and interest (60/365 × $5,856); court’s approach Remainder Less: Utilities and maintenance (60/120 × $2,600) Remainder Less: Depreciation ($3,500, limited to $1,737) Net income from vacation home

$ 4,000 (963) $ 3,037 (1,300) $ 1,737 (1,737) $ –0–

Note that $4,893 ($5,856 total − $963 vacation home portion) of property tax and mortgage interest on the vacation home are itemized deductions. (3) State income taxes paid ($3,300) exceed state sales taxes paid ($900). (4) Tax preparation fees are miscellaneous itemized deductions and are not deductible. 51. (LO 1, 3, 4) a. Sales revenue Deduct:

AGI

Cost of goods sold Advertising Utilities Rent Insurance Wages to Boyd

$90,000 8,000 5,000 10,000 3,000 1 5,000

$275,000

(1 31,000) $144,000

Elisa and Clyde can deduct only the $15,000 in wages they paid to Boyd. They cannot deduct the $2,000 paid by Chelsea. b. Chelsea is not entitled to a deduction on her tax return. The obligation is that of Elisa and Clyde because it is related to their business.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

c. If Chelsea made a gift of the $2,000 to Elisa and Clyde or loaned the $2,000 to them, they could deduct it if they paid the $2,000 to Boyd. 52. (LO 3, 4) a. Brittany’s $24,000 loss ($160,000 amount realized − $184,000 adjusted basis) is not deductible due to § 267 (it is a related-party transaction). b. If the stock is sold for $190,000, Ridge’s recognized gain is $6,000 [$190,000 (sales price) less $160,000 (basis), reduced by the $24,000 loss that previously was not allowed to Brittany]. If the stock is sold for $152,000, an $8,000 loss [$152,000 (sales price) less $160,000 (basis)] is recognized by Ridge. The $24,000 loss that was realized by Brittany is not deductible by either Brittany or Ridge and is lost permanently (the previous disallowed loss cannot be used to increase a subsequent loss). If the stock is sold for $174,000, there is no recognized gain to Ridge [$174,000 (sales price) less $160,000 (basis), reduced by $14,000 of the $24,000 loss that previously was not recognized by Brittany]. The remaining $10,000 of unrecognized loss is lost permanently as a deduction for both Brittany and Ridge. c. Spreadsheet formulas are presented below:

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 June 21, 2024 Ms. Brittany Callihan 32 Country Lane Lawrence, KS 66045 Dear Ms. Callihan: As you requested in your note, I am providing you with the tax consequences of the proposed sale of stock to your son Ridge. Although you would have a potential loss of $24,000 ($160,000 selling price − $184,000 cost), you would not be able to recognize this loss on your tax return. The tax law disallows the recognition of losses between certain related parties.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

If you sell the stock to Ridge, his tax basis for calculating gain or loss on a subsequent sale by him would be his cost of $160,000. However, if he should sell it at a gain, he could use as much of your $24,000 disallowed loss as necessary to reduce his gain to zero. From a planning perspective, you could recognize the $24,000 loss on your tax return if you were to sell the stock to an unrelated party rather than selling it to Ridge. If you would like to discuss this further, please let me know. Sincerely, Ellen Allen, CPA Tax Partner 53. (LO 3) a. Amount realized Adjusted basis Realized loss Recognized loss

$ 12,000 (17,000) ($ 5,000) $

–0–

Kiera and Phillip are related parties under § 267. Therefore, Kiera’s realized loss of $5,000 is disallowed. Phillip’s adjusted basis for the stock is his cost of $12,000. b. Amount realized Adjusted basis Realized loss

$ 70,000 (85,000) ($ 15,000)

Recognized loss

($ 15,000)

Darnell and Boyd (uncle and nephew) are not related parties under § 267. Therefore, Darnell’s realized loss of $15,000 is recognized. Boyd’s adjusted basis for the land is his cost of $70,000. c. Amount realized Adjusted basis Realized loss Recognized loss

$ 19,000 (20,000) ($ 1,000) $

–0–

Susan and her wholly owned corporation are related parties under § 267 (i.e., she owns greater than 50% in value of the outstanding stock). Therefore, Susan’s realized loss of $1,000 is disallowed. The corporation’s adjusted basis for the bond is its cost of $19,000. d. Amount realized Adjusted basis Realized loss Recognized loss

$ 18,500 (20,000) ($ 1,500) ($

1,500)

Sinbad and Agnes (cousins) are not related parties under § 267. Therefore, Sinbad’s realized loss of $1,500 is recognized. Agnes’s adjusted basis for the truck is her cost of $18,500.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

e. Amount realized Adjusted basis Realized gain

$220,000 (175,000) $ 45,000

Recognized gain

$ 45,000

Martha and Kim are related parties under § 267. However, § 267 applies only to loss transactions. Martha’s realized gain of $45,000 is recognized, and Kim’s adjusted basis for her partnership interest is her cost of $220,000. 54. (LO 1, 3, 4) a. Robert can deduct only amounts that are his obligations. He may not deduct amounts that are obligations of his daughter, Anne. Therefore, Robert can deduct only the following as itemized deductions: Property taxes on his home Mortgage interest on his home Total

$ 3,000 8,000 $11,000

The repairs of $1,200 and the utilities of $2,700 paid by Robert associated with his home are nondeductible personal expenditures. The roof replacement costs of $14,000 on Robert’s home are not deductible, but he can add them to his adjusted basis for the home. b. Anne may not be able to deduct the $1,500 property taxes because she did not pay the property taxes. However, the Tax Court allowed a deduction when a mother made payments for medical expenses and property taxes directly to the medical services provider and the city government, respectively, on behalf of her daughter (Judith F. Lang, 100 TCM 603, T.C.Memo. 2010–286). The Tax Court deemed the payments a gift to the daughter, who then made deemed payments to satisfy her obligations. By relying on this case, Anne might be able to claim a deduction for the property taxes. c. Robert’s deductions are deductions from AGI (itemized deductions). d. Anne could deduct the property taxes of $1,500 as itemized deductions if she paid them. Therefore, Robert should make a gift (or loan) of $1,500 to Anne so that she could pay these expenses. 55. (LO 3) a.

Interest expense is limited to $172,000, the sum of MSU’s $22,000 of business interest income plus 30% of its adjusted taxable income (30% × $500,000 = $150,000). Because MSU’s interest expense ($120,000) is less than the $172,000 limitation, the entire interest expense of $120,000 can be deducted.

b. Interest expense is limited to $112,000, the sum of MSU’s $22,000 of business interest income plus 30% of its adjusted taxable income (30% × $300,000 = $90,000). Therefore, only $112,000 of the interest expense of $120,000 can be deducted in 2024. The remaining interest expense ($8,000) is carried over indefinitely.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

TAX RETURN PROBLEMS 56. Salary Inheritance (Note 1) Gift (Note 1) Life insurance proceeds (Note 1) Net gain on stock sale (Note 2) Interest income (Note 3) Dividend income Prize Alimony (Note 4) Partnership income (Note 5) AGI Itemized deductions: Charitable contributions ($4,500 + $1,500) Home mortgage interest Property taxes ($3,200 + $1,100) State income taxes ($4,400 + $1,000) (Note 6) Medical expenses (Note 7)

$136,000 –0– –0– –0– 3,500 2,500 1,800 750 –0– 5,300 $149,850 $ 6,000 7,800 4,300 5,400 –0–

Less: Deduction for qualified business income (Note 10) Taxable income (Notes 8 and 9)

(23,500) $126,350 (1,060) $125,290

Tax on $125,290 (Note 11) Less: Child and dependent tax credits (Note 12) Less: Withholding and estimated tax ($16,000 + $2,800) Net tax payable (or refund due) for 2023

$ 21,387 (2,500) (18,800) $ 87

Completed tax forms for this problem are available on the Cengage Instructor Center. Notes (1)

The inheritance of $625,000, life insurance proceeds of $300,000, and gift of $15,000 all are excludible from Roberta’s gross income.

(2)

Roberta’s adjusted basis for the Amber stock is $24,000, the purchase price. A cousin is not a related party. As a result, Roberta has a recognized loss of $2,000 ($22,000 amount realized − $24,000 adjusted basis). Because her holding period for the stock is long term, the loss is classified as long-term capital loss. Roberta has a gain on the sale of the Falcon stock of $5,500 ($13,500 amount realized − $8,000 adjusted basis). Because her holding period for the stock is long term, the gain is classified as long-term capital gain. Thus, she has capital gain net income and net capital gain of $3,500 ($5,500 − $2,000).

(3)

The $2,500 of interest received from First Savings Bank is includible in Roberta’s gross income. The $3,750 of interest received on the City of Springfield school bonds is excludible from gross income.

(4)

Because the divorce was finalized after 2018, the alimony received is not included in Roberta’s income.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

(5)

Roberta reports her distributive share of the partnership taxable income of $5,300 rather than the amount of the distribution she received of $4,800.

(6)

The state income taxes of $5,400 exceed the sales tax table amount of $1,808. Her total state taxes (property taxes of $4,300 and income taxes of $5,400) are less than the $10,000 overall limit on personal taxes.

(7)

Roberta’s deductible medical expenses are $0. Roberta Jason Less reimbursement Less 7.5% of $149,850 Deductible medical expenses

5,000 800 $ 5,800 (1,500) $ 4,300 (11,239) $ –0–

The $5,000 of medical expenses paid for a friend are not deductible. Further, this cannot be treated as a donation; the payment is related to medical expenses, not a donation to a qualified charitable organization. (8)

The parking ticket of $1,000 and the related attorney’s fee of $500 cannot be deducted.

(9)

The political contribution of $250 cannot be deducted.

(10)

Roberta’s qualified business income deduction is $1,060 ($5,300 partnership income × 20%).

(11)

Roberta’s tax liability is $21,387. The dividend income and net capital gain are taxed at a 15% rate. $1,800 + $3,500 = $5,300 × 15% = $795 The tax liability as a head of household on the balance of $119,990 ($125,290 – $5,300) from the 2023 Tax Rate Schedules is $20,592. So Roberta’s tax liability is $21,387 ($795 + $20,592).

(12)

Jason qualifies for the child tax credit. The $2,000 child credit is subject to a phaseout, but only when AGI exceeds $200,000 for Head of Household filers. As a result, there is no phaseout of the $2,000 child tax credit. June qualifies for the $500 dependent tax credit. So, in total, the child and dependent tax credit is $2,500.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

57. Part 1—Tax Computation Salaries ($125,000 + $62,000) (Note 1) Interest on certificates of deposit Share of S corporation income (Note 2) Award Child support (Note 3) AGI (Note 4) Itemized deductions: Medical expenses (Note 5) Charitable contributions State and Local Taxes: Property State income ($5,700 + $3,100 + $1,800) (Limited to $10,000; see Note 6) Home mortgage interest

$187,000 3,500 4,500 4,000 –0– $199,000 $ –0– 8,700 $ 4,800 10,600 $15,400

10,000 13,800

Less: Deduction for qualified business income (Note 7) Taxable income (Note 8)

(32,500) $166,500 (900) $165,600

Tax on $165,600 (Note 9) Less: Withholding ($22,800 + $5,600) Net tax payable (or refund due) for 2024

$ 26,538 (28,400) ($ 1,862)

Notes (1)

The medical insurance premiums of $21,350 paid by John’s employer are excludible from gross income. Likewise, the $7,300 of medical benefits received under the plan by Mary Jane are excludible.

(2)

Mary Jane includes her share of the S corporation income of $4,500 in her gross income even though she received cash distributions of only $1,100.

(3)

Child support payments of $15,000 are not deductible. See Chapter 4.

(4)

The investigation expenses of $15,000 incurred by John and associated with the retail computer franchise are not deductible. This result occurs because John was not in a business that was the same as or similar to the one being investigated and the new business was not acquired.

(5)

John pays medical insurance premiums of $4,270. Mary Jane pays noncovered medical expenses of $1,300. Their medical expense deduction is $0 because their payments are less than 7.5% of AGI (7.5% × $199,000 = $14,925).

(6)

The state income taxes paid of $10,600 ($5,700 + $3,100 + $1,800) exceed the state sales taxes of $2,000. The total deduction for state property and income taxes cannot exceed $10,000.

(7)

Mary Jane’s qualified business income deduction is $900 ($4,500 × 20%).

(8)

The $150 ticket associated with Mary Jane running a red light is a nondeductible personal expenditure.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

(9)

Because they are filing jointly, their tax liability for 2024 is calculated as follows based on the Tax Rate Schedules: [($165,600 – $94,300) × 22%] + $10,852 = $26,538 A dependent tax credit is not allowed for either Rod (John’s son) or Mary Jane’s father. Although John provides support to his son, Rod is living with Jill (who is the custodial parent). As a result, Rod is a dependent of Jill. In addition, Mary Jane’s father does not qualify as a dependent. John and Mary Jane do provide over half of his support (i.e., $11,000 furnished by them compared with $5,400 provided by her father). However, the father fails the gross income test. His gross income is $7,300 ($3,800 salary + $3,500 unemployment compensation benefits), which exceeds the allowable amount (less than $5,050).

Part 2—Tax Planning SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 December 16, 2024 Mr. and Mrs. John Diaz 204 Shoe Lane Blacksburg, VA 24061 Dear Mr. and Mrs. Diaz: I am responding to your inquiry regarding whether John should receive a $45,000 bonus in 2024 or delay receiving it until 2025. Based on the data provided by you, I have calculated your tax liability for both years assuming that the bonus is received in 2024 and assuming that the bonus is received in 2025.* The tax liability results are as follows: Tax taking the bonus in 2024: For 2024 For 2025 Total tax

$36,629 10,018 $46,647

Tax taking the bonus in 2025: For 2024 For 2025 Total tax

$26,538 19,918 $46,456

If you delay the receipt of the bonus until 2025, you will save $191 ($46,647 − $46,456). This ignores any earnings (net of taxes) you could receive on the $45,000 if you received the bonus in 2024. However, because any earnings relate to no more than one month (the decision is whether to receive the bonus in either December 2024 or January 2025), the amount of such earnings is likely to be negligible. If I can be of further assistance, let me know. Sincerely, Rene Ross, CPA Partner *2024 tax rates used.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

TAX FILE MEMORANDUM DATE:

December 9, 2024

FROM:

Rene Ross

SUBJECT:

John and Mary Jane Diaz Tax Planning Regarding Timing of Bonus

John Diaz, a tax client, has an opportunity to receive a $45,000 bonus in December 2024 or in January 2025. He has asked that we make a recommendation on whether he should receive the bonus in 2024 or delay it until next year. Expected differences in 2025 to the data provided in preparing their 2024 return are as follows: (1)

They are expecting a child in January 2025.

(2)

Mary Jane will quit work on December 31, 2024, to stay home with the child. As a result, her salary will decrease by $62,000 and the state income taxes withheld on the $62,000 will decrease by $3,100.

(3)

Mary Jane will not receive an employee award in 2025.

(4)

Medical benefits received by Mary Jane in 2025 will be $9,000 rather than the $7,300 received in 2024, and these benefits are not taxable in either year. Based on the data provided for the 2024* taxes and the above assumptions, I made the following calculations: Tax with the Bonus: Taxable income in 2024 Bonus Less: Mary Jane’s salary Award Plus: Decrease in itemized deductions (Note 1) Taxable income with bonus

2024 $165,600 45,000

$210,600

2025 $165,600 45,000 (62,000) (4,000) –0– $144,600

Tax before credits* Child tax credit Tax

$ 36,629 –0– $ 36,629

$ 21,9 1 8 (2,000) $ 19,9 18

Taxable income with bonus Less: Bonus Taxable income without bonus

$2 10,600 (45,000) $165,600

$144,600 (45,000) $ 99,600

Tax before credits* Child tax credit Tax

$ 26,538 –0– $ 26,538

$ 1 2,0 1 8 (2,000) $ 10,018

Tax without the Bonus:

Tax taking the bonus in 2024: For 2024 For 2025 Total tax

$ 36,629 10,0 18 $ 46,647

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

Tax taking the bonus in 2025: For 2024 For 2025 Total tax

$ 26,538 19 , 91 8 $ 46,456

They will save $191 ($46,647 − $46,456) by deferring the bonus to January 2025. *2024 tax rates used. Notes (1)

State income taxes are reduced by $3,100, so the total amount of taxes for 2025 is $12,300. However, the deduction for state and local taxes cannot exceed $10,000 for 2025, so there is no change from 2024.

RESEARCH PROBLEMS 1.

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 March 25, 2025 Mr. Ted Jones, President Gray Chemical Company 200 Lincoln Center Omaha, NE 68182 Dear Mr. Jones: This letter is in response to your request to provide Gray Chemical Company with tax advice regarding the deductibility of the following: •

$8 million contribution to a charitable fund whose purpose is bettering the environment.

•

$7 million fine for EPA violations.

•

Legal fees related to both of these expenses.

Based on our research, neither the $8 million contribution nor the $7 million fine is deductible. The deduction of the fine is disallowed under Internal Revenue Code § 162(f). Because the $8 million contribution resulted in the court reducing the fine from $15 million to $7 million, the $8 million payment is in substance viewed as a fine or similar penalty and is therefore not deductible. All of the related legal fees are deductible under Internal Revenue Code § 162(a). If we can be of additional service, please let me know. Sincerely, Gayle B. Anders, CPA Partner

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

TAX FILE MEMORANDUM DATE:

March 20, 2025

FROM:

Gayle B. Anders

SUBJECT:

Deductibility of Costs Associated with EPA Violations by Gray Chemical Company

Ted Jones, the president of Gray Chemical Company (Gray), a regular audit client, has requested that we provide tax advice regarding the deductibility of the following: •

$8 million contribution to a charitable fund whose purpose is bettering the environment.

•

$7 million fine for EPA violations.

•

Legal fees related to both of these expenses.

Gray deducted the $8 million contribution and the related legal expenses incurred in setting up the foundation. In addition, Gray deducted the legal costs of defending itself in court. Gray did not deduct the $7 million fine. On audit, the IRS disallowed the deductions taken by Gray on the grounds that the payment was, in fact, a violation of public policy and therefore not deductible under § 162(f). Of additional relevance is the fact that the court initially imposed a fine of $15 million for the EPA violations. After Gray set up the foundation with the $8 million contribution, the court reduced the fine to $7 million. A case in point on the issues involved is Allied-Signal, Inc., 63 TCM 2672, T.C.Memo. 1992–204. The court held that the $8 million paid to the foundation was in substance a “fine or similar penalty” within the meaning of § 162(f). Its reasoning was based, in part, on the fact that negotiations with the judge indicated that he wanted to find a way to keep some of the penalty in the injured state rather than have the entire fine go to the Federal government. The defendant’s lawyer also discussed with the client and the judge techniques for making the foundation payment tax deductible. The reduction of the fine, although not guaranteed, was implied by the court during these discussions. The legal fees incurred by Allied in defending its prosecution and in setting up the foundation were deductible with the intent of § 162(a). The court cited Reg. § 1.162– 21(b)(2) which provides that the disallowance rule of § 162(f) does not apply to legal fees “incurred in the defense of a prosecution or civil action arising from a violation of the law imposing the fine or civil penalty.” I have notified Gray that only the legal expenses can be deducted. 2. Rex and Agnes can treat the beach house as rental property and are eligible to deduct the items they deducted on their income tax return. Facts and circumstances similar to those of Rex and Agnes appear in Robert J. Twohey, 66 TCM 1394, T.C.Memo. 1993– 547.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

The key issue is whether the allowable 14 days of personal use was exceeded. According to the records of Rex and Agnes, only 14 days of their occupancy were on days they were not working on the beach house. If only these days are counted, then the § 280A(d)(1) provision is satisfied. Under this provision, personal use cannot exceed the greater of (1) 14 days or (2) 10% of the rental days. If instead the entire 38 days of their occupancy are counted as personal use days, then their deductions for the beach house will be limited to the rental income. Code § 280A(d)(2) provides that if the taxpayer is engaged in repair and maintenance on a substantially full-time basis on any day, such use will not constitute personal use of the vacation home. The fact that other family members were there who were not engaged in work does not change this result. In Robert J. Twohey, the Tax Court chose to reject the IRS position that some of the alleged repair and maintenance days should be counted as personal use days instead because only capital expenditures were performed. This conclusion was based on the state of disrepair of the rental property at the time of its acquisition. 3. On facts similar to those of Mona, the Tax Court found for the taxpayer in Lee Storey, 103 TCM 1631, T.C.Memo. 2012–115. The primary issue before the Tax Court was whether Storey’s documentary film production activity was a hobby or a trade or business activity. In deciding whether this activity was for profit, the Tax Court applied the nine tests contained in Reg. § 1.183–2(b) to the taxpayer’s situation. •

Manner in which the taxpayer conducts the activity—was the activity conducted in a businesslike manner? Factors supporting this test include the taxpayer’s business plan, maintenance of accounts and complete books and records, and the marketing of the completed film.

•

Expertise of the taxpayer and the taxpayer’s advisers. o

•

Time and effort expended by the taxpayer. o

•

Over the three-year period, she devoted many nights and weekends to developing her filmmaking abilities and to producing the documentary.

Expectation that property used in the activity would appreciate in value. o

•

Taxpayer devoted substantial time and effort in developing her expertise in filmmaking. She conducted the activity with the assistance of other qualified team members.

Taxpayer believed that the film would appreciate in value. She also thought that the rights to footage of Way to Sing America would increase in value. The IRS believed that neither of these assets had value, much less would increase in value. The Tax Court concluded that this test appeared to be neutral.

Taxpayer’s success in carrying on similar activities. o

Because this is the taxpayer’s first filmmaking activity, this test is of little direct relevance. However, her success in other art-related activities and in her law firm should count in her favor.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

•

Taxpayer’s history of income and losses and amount of occasional profits. o

•

Financial status of the taxpayer. o

•

Because this three-year interval can be viewed as the startup period during which only losses are expected, the Tax Court did not consider this test to be relevant.

The Tax Court viewed this test as favoring the IRS. Being able to deduct her losses against her law firm income produced significant tax benefits.

Whether elements of personal pleasure are involved. o

The taxpayer did obtain personal pleasure from this filmmaking activity. However, this is only one of the nine tests and no one by itself is conclusive.

After evaluating these nine factors in light of the facts and circumstances, the Tax Court concluded that the taxpayer did engage in the filmmaking activity with the objective of making a profit. Because Mona’s facts and circumstances are similar to those in Lee Storey, she should be permitted to deduct her losses against income from her law firm.

RESEARCH PROBLEMS 4 TO 6 These research problems require that students utilize online resources to research and answer the questions. As a result, solutions may vary among students and courses. You should determine the skill and experience levels of the students before assigning these problems, coaching where necessary. Encourage students to use reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax professionals, academics, think tanks, and political outlets to research their answers. 4. The FAQ section of many IRA provider websites indicates that tax-deductible contributions for 2024 can be made until the tax return due date (normally, April 15, 2025): investor.vanguard.com/investor-resources-education/iras/roth-vs-traditional-ira 5. Academic and professional research suggests that § 162(m) has not reduced executive compensation. An article that examines the tax cost associated with the inability to deduct executive compensation is Theo Francis, “Companies Feel Tax Bite After Raising Executive Pay,” Wall Street Journal, July 22, 2022, page B1. An academic article that finds no effect from § 162(m) on executive compensation is Lisa De Simone, Charles McClure and Bridget Stomberg, “Examining the Effects of the Tax Cuts and Jobs Act on Executive Compensation,” Contemporary Accounting Research, June 29, 2022; doi.org/10.1111/1911-3846.12801.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

6. Student responses will vary. During the development process for the 2025 edition, ChatGPT provided a fairly good response to both questions. For part (1), its response included having receipts or invoices with the amount, date, and nature of the expense, canceled checks, bank statements, credit card statements, mileage logs, travel records, and entertainment documentation (including the nature of discussions during the entertainment). For part (2), it encouraged the use of accounting software, creating and maintaining digital copies of documents, keeping business and personal expenses in separate accounts, maintaining a filing system, and regularly reconciling accounts. As students evaluate responses from an AI tool, the tool should identify that the substantiation required for travel and entertainment expenses under § 274 is more detailed than what is normally required for business expenses under § 162. In addition, does the tool address the role of per diem rates?

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

CHECK FIGURES 26.a. 26.b. 27.a. 27.b. 28. 29. 30.a. 30.b. 31. 32. 33.a. 34.a. 34.b. 35. 36. 37.a. 37.b. 38.a. 38.b. 39. 40.a. 40.b. 41. 42. 43.a. 43.b. 43.c. 43.d. 44.a. 44.b.

$8,400. $3,150. $500,000. $545,000. $73,333. $291,400. $10,000. $0. $4,522. $17,500. AGI reduced by $4,850. AGI is $86,500. Select itemized deductions of $20,000. With IRA contribution $15,775; without IRA contribution $14,900. Deduct $4,000. $30,000. $45,000. $85,000. $1,000. $500. Increase AGI by $31,000. Increase taxable income by $31,000. Continue the performance-based compensation program without any changes. $38,133. $52,000. $52,000. $0. $3,817. Decrease AGI by $1,940 loss. $20,000 revenue reported.

45. 46.a. 46.b. 47. 48.a. 48.b. 49. 50. 51.a. 51.b. 51.c. 52.a. 52.b. 53.a. 53.b. 53.c. 53.d. 53.e. 54.a. 54.b. 54.c. 55.a. 55.b. 56. 57.

Revenue of $18,000 reported and $3,000 of property taxes. Exclude rent income from gross income; no impact on AGI. Deduct $11,500 from AGI. No impact on AGI. Net rental income $0; itemized deduction $10,555. Net rental income $0; itemized deduction $4,600. Net rental loss $12,488; itemized deduction $325. $53,507. $144,000. $0. Chelsea should give or loan $2,000 to Elisa and Clyde, who then pay $2,000 to Boyd. Loss of $24,000 is not deductible. Gain $6,000; loss $8,000; $0. $0 loss; $12,000 basis. $15,000 loss; $70,000 basis. $0 loss; $19,000 basis. $1,500 loss; $18,500 basis. $45,000 gain; $220,000 basis. $11,000. No. Deductions from AGI. $120,000. $112,000. Tax payable for 2023: $87. Refund for 2024: $1,862.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

SOLUTIONS TO ETHICS & EQUITY FEATURES State Allowed Marijuana Activity: Do Regular Business Deduction Rules Apply (or Those for Drug Dealers)? (p. 6-15). Expenses related to illegal drug businesses are not deductible, except for cost of goods sold. However, what is the proper tax result when state law and Federal law are in conflict with the definition of an illegal activity? The Tax Court was presented with this situation [Martin Olive, 139 T.C. 19 (2012)]. Martin Olive operated a medical marijuana business in California under the California Compassionate Use Act of 1996 (CCUA). Olive argued that his business was not involved in the illegal trafficking of a controlled substance because of the CCUA. He also argued that even if the expenses for dispensing the marijuana were disallowed, he had a separate line of business for caregiving and most of his expenses related to delivering care to his customers. The Tax Court ruled that the expenses incurred in dispensing medical marijuana are not deductible even if the business is legal under state law. The Tax Court also ruled that Olive did not have two separate lines of business. Thus, the Tax Court has established that Federal law is used to determine whether an activity is illegal for Federal income tax purposes. Given this precedent by the Tax Court and the clearly established laws prohibiting deductions (other than cost of goods sold) by illegal drug businesses, Cole should report $80,000 of taxable income (revenues of $200,000 less cost of goods sold of $120,000) and not deduct the other expenses. Cole should check California tax law to determine if the other expenses are deductible in computing his California income tax liability. But Federal law governs the taxation of Federal income, and the business is illegal according to Federal law. Therefore, to deduct the other expenses would not be an appropriate position. This ruling was affirmed by the 9th Circuit Court of Appeals [2015–2 USTC ¶50377, 116 AFTR 2d 2015–5150, 792 F.3d 1146 (CA–9)]. Similarly, see Patients Mutual Assistance Collective Corp., 151 T.C. 176 (2018). Personal or Business Expenses? (p. 6-26). Jaynice has created an ethical and legal problem for herself by deducting personal expenses against her business income. One of the most common types of tax evasion involves business owners who attempt to “hide” personal expenses as business deductions. To file an appropriate tax return, Jaynice needs to do the following: 1.

Prorate the mortgage interest, depreciation, and taxes between the use of the property as a personal residence (30%) and business property (70%). Only the business expenses should be deducted on Schedule C. The personal portion of the interest and taxes is reported on Schedule A as an itemized deduction. The personal portion of the depreciation is not deductible.

2. Establish a reasonable method to prove the percentage of the groceries that are consumed by the guests at the lodge. Jaynice has the burden of proof; so if she cannot establish this, the groceries will be treated as personal expenses. In no event should she deduct expenses related to food consumed by her and her family.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

SOLUTIONS TO BECKER CPA REVIEW QUESTIONS 1.

Choice “b” is correct. Business expenses of a sole proprietor are classified as deductions for AGI. Choice “a” is incorrect. Charitable contributions of property are an itemized deduction, which is a deduction from AGI. There is a deduction from AGI for individuals who do not itemize deductions, but it is only for cash contributions to public charities and is limited to $300. Choice “c” is incorrect. State and local income taxes are an itemized deduction, which is a deduction from AGI. Choice “d” is incorrect. Mortgage interest paid on your primary residence is an itemized deduction, which is a deduction from AGI.

2. Choice “c” is correct. Property taxes paid on your primary residence is an itemized deduction, which is a deduction from AGI. Choice “a” is incorrect. A contribution to a retirement plan by a self-employed individual is a deduction for AGI. Choice “b” is incorrect. Business rent on a self-employed business is deductible on Schedule C. This is before the calculation of AGI. Choice “d” is incorrect. One-half of self-employment tax is an adjustment, which is a deduction for AGI. 3. Choice “b” is correct. Gambling winnings are included in gross income. Gambling losses are deductible to the extent of gambling winnings, but are deducted on Schedule A and not calculated as part of gross income. Choices “a,” “c,” and “d” are incorrect, based on the above explanation. 4. Choice “c” is correct. Bob’s beginning inventory $10,000 + purchases $3,000 – $4,000 ending inventory = $9,000 cost of sales. If net sales totaled $17,000, then $17,000 sales – $9,000 cost of sales = $8,000 gross profit. Choice “a” is incorrect. This is equal to Bob’s cost of sales based on the change in inventory. Choice “b” is incorrect. This is the amount of Bob’s net sales. Gross profit is calculated as sales minus cost of sales. Choice “d” is incorrect. This amount is equal to Bob’s net sales less the amount of the ending inventory rather than the change in inventory or cost of sales.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

5. Choice “c” is correct. Real estate taxes and mortgage interest are either deducted on the rental Schedule E or as an itemized deduction (subject to limitations). Therefore, real estate taxes will be deductible whether the Griffins rent their cabin or not. Choice “a” is incorrect. Only the rental portion of the utilities is deducted on Schedule E. Because the Griffins rented their cabin for more than 15 days and used the cabin for the greater of (1) 14 days or (2) more than 10% of the rental days, their cabin is treated as a personal/rental residence. The rental portion is deducted on Schedule E. The personal use portion of the utilities expense is not deductible. Choice “b” is incorrect. Depreciation is only deductible as a rental expense on Schedule E. If the Griffins had rented their cabin out for fewer than 15 days, then the cabin would be treated as a personal residence. As a personal residence, depreciation is not deductible. Therefore, depreciation is not deductible under all rental circumstances. Choice “d” is incorrect. Because the Griffins rented their cabin for more than 15 days and used the cabin for the greater of (1) 14 days or (2) more than 10% of the rental days, their cabin is treated as a personal/rental residence. The Griffins would include the rental income received in their gross income on Schedule E. 6. Choice “b” is correct. Because the Groves rented their cabin for fewer than 15 days, it is treated as a personal residence. Therefore, the rental income is excluded from gross income and mortgage interest and real estate taxes are deductible as itemized deductions on Schedule A (subject to limitations). Choice “a” is incorrect. Because the Groves rented their cabin for fewer than 15 days, it is treated as a personal residence. Mortgage interest and real estate taxes are deductible as itemized deductions on Schedule A (subject to limitations). Choices “c” and “d” are incorrect. Because the Groves rented their cabin for fewer than 15 days, it is treated as a personal residence. Therefore, repairs, utilities, depreciation, and other allowed rental expenses are not deductible.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

7. Choice “d” is correct. The answer is calculated as follows: Gross revenue Rent expense Wages paid to employees Wages paid to Marty Payroll taxes for employees Supplies expense Insurance expense Depreciation expense Business meals Health insurance for employees Health insurance for Marty

$275,000 24,000 60,000 — 5,000 10,000 8,000 15,000 2,000 5,000 —

Business bad debt (allowance)

—

State income taxes for the business

—

Schedule C

$146,000

[considered a draw, not an expense]

[only 50% deductible] [not deducted on Schedule C; 100% is an adjustment for AGI] [direct write-off only for accrual basis taxpayers] [not deducted on Schedule C; an itemized deduction]

Choices “a,” “b,” and “c” are incorrect, per the above calculation. Note that while state and local business taxes are fully deductible on Schedule C, state and local income taxes are always a personal expense that can only be deducted on Schedule A. 8. Choice “b” is correct. Self-employment income is subject to Federal income tax and self-employment tax. The self-employment tax is made up of Social Security (12.4%) and Medicare (2.9%), for a total of 15.3%. Choice “a” is incorrect. Income from self-employment is reported on Schedule C of Form 1040. Choice “c” is incorrect. One half of self-employment tax is deductible as a deduction, or adjustment, for AGI deduction. Choice “d” is incorrect. All self-employment income is subject to the 2.9% Medicare tax, but Social Security tax is subject to the 12.4% tax only up to a certain threshold. 9. Choice “c” is correct. The basic calculation for the QBI deduction is 20% × QBI. The deduction is subject to limitations. Choices “a,” “b,” and “d” are incorrect; the basic calculation for the QBI deduction is 20% × QBI. 10. Choice “a” is correct. Accounting services are considered an SSTB for purposes of the qualified business income deduction. Choice “b” is incorrect. A manufacturing firm is a qualified trade or business (QTB) and not an SSTB. Choice “c” is incorrect. An engineering firm is specifically excluded from the definition of an SSTB. Choice “d” is incorrect. Architectural services are specifically excluded from the definition of an SSTB.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 6: Deductions and Losses: In General

11. Choice “c” is correct. Jennifer’s activity is not engaged in for profit (a hobby), so she cannot deduct any of the expenses that would be deductible if the activity were engaged in for profit (a business). She is still required to include the $1,000 gross income from the activity in her taxable income. Choice “a” is incorrect. A $300 decrease would include a deduction for all the expenses related to her dog show activity ($1,000 gross income – $1,300 expenses = $300 loss). The gross income from the activity is included in taxable income but no deduction is allowed for the expenses related to the dog show activity because the activity is not engaged in for profit (a hobby). Choice “b” is incorrect. A $100 decrease would include a deduction for the dog food and veterinary fees, but not the travel to the dog shows ($1,000 gross income – $300 dog food expense – $800 veterinary fees = $100 loss). The gross income from the activity is included in taxable income but no deduction is allowed for the expenses related to the dog show activity because the activity is not engaged in for profit (a hobby). Choice “d” is incorrect. The dog show activity is not engaged in for profit, so no deduction is allowed for the expenses related to the activity. However, the gross income from the activity is still included in taxable income.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 7: Deductions and Losses: Certain Business Expenses and Losses

Solution and Answer Guide

YOUNG, PERSELLIN, NELLEN, MALONEY, CUCCIA, LASSAR, CRIPE, SWFT COMPREHENSIVE VOLUME 2025, 9780357988817; CHAPTER 7: DEDUCTIONS AND LOSSES: CERTAIN BUSINESS EXPENSES AND LOSSES

TABLE OF CONTENTS Discussion Questions...........................................................................................................1 Computational Exercises ................................................................................................... 3 Problems ............................................................................................................................. 6 Tax Return Problems ........................................................................................................ 19 Research Problems ........................................................................................................... 23 Check Figures.................................................................................................................... 24 Solution To Ethics & Equity Feature ................................................................................ 25 Solutions To Becker CPA Review Questions ................................................................... 26

DISCUSSION QUESTIONS 1.

(LO 1) 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.

2. (LO 1) Ron has no bad debt deduction because he is a cash basis taxpayer. Rather, Ron has $70,000 of income. 3. (LO 1) 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. 4. (LO 1) The business bad debt is treated as an ordinary loss; hence, the fact that the business has long-term capital gains has no relevance. 5. (LO 1, 2, 3, 4, 7) 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?

If an NOL is created, what are the NOL carryforward implications?

Is it § 1244 stock?

6. (LO 1, 2) 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. 7. (LO 2) The gain on the sale of § 1244 stock is treated as a capital gain (§ 1244 applies to losses, not gains). 8. (LO 3, 4) 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 (it is not considered a sudden event). From 2018 through 2025, personal casualty losses are only allowed if the loss occurs in a Federally declared disaster area. 9. (LO 3, 4) Casualty losses are not allowed for a decline in the value of the property. Losses are allowed only for actual damage. 10. (LO 4) Generally, a theft loss is deducted in the year of discovery. However, no theft 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 of discovery, and the remainder is deducted in the year the claim is settled. 11. (LO 4) 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. 12. (LO 4) If the painting is treated as investment property, the loss is $20,000 (the painting’s adjusted basis) and is treated as a non-miscellaneous itemized deduction (miscellaneous itemized deductions―subject to a 2%-of-AGI floor―are not deductible from 2018 through 2025). As a result, all of the $20,000 could be taken as a deduction. If the painting is treated as personal use property, the amount of the loss is limited to $20,000, and, because the loss is not related to a Federally declared disaster area, it is not deductible. 13. (LO 2, 4) Kelly should be concerned with the following issues: •

Is this a theft loss or an investment loss?

•

What is the amount of the loss? Is the loss deductible?

•

In which year can the loss be taken?

•

Does the stock qualify as § 1244 stock?

14. (LO 3, 4) The tax issues for John are as follows: •

Is the loss a theft loss or an investment loss?

•

How is the amount of the loss determined?

•

What year can the loss be taken?

•

Is the loss subject to the personal casualty and theft loss limits ($100 floor and 10%-of-AGI floor)? Is the loss a miscellaneous itemized deduction (and, therefore, not deductible)?

15. (LO 5) Research and experimental expenditures incurred during the year must be capitalized and amortized over five years starting at the midpoint of the year. Thus, in the first year, one-tenth of that year’s research and experimental expenditures are deducted, one-fifth in the next four years, and one-tenth in the sixth year. 16. (LO 6, 7) The tax issues for Amos are as follows: •

Does Amos have any other income (e.g., spouse salary, investment income)? Will the loss be subject to the excess business loss rules?

•

Will the loss generate a net operating loss for Amos? If so, when can the related deduction be claimed? Can the NOL be carried back?

17. (LO 6) The purpose of the excess business loss limitation is to limit the amount of nonbusiness income (e.g., salaries, interest, dividends, and capital gains) that can be “sheltered” from tax as a result of business losses. 18. (LO 7) An unreimbursed employee business expense is a miscellaneous itemized deduction. From 2018 through 2025, miscellaneous itemized deductions are not allowed. As a result, although the expense is a business expense, it is not currently deductible and, therefore, cannot create or increase an NOL for an individual taxpayer. 19. (LO 7) 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. 20. (LO 7) The tax issues for Thomas are as follows: •

Are the following items trade or business deductions and, hence, deductible in computing an NOL? o

Alimony payments.

Contributions to a traditional IRA.

COMPUTATIONAL EXERCISES 21. (LO 1) Aleshia must include the $8,000 in gross income of the current tax year, but only to the extent of the tax benefit in the previous year. Because Aleshia had capital gains of $12,000 in the previous year, all of the $15,000 bad debt would have been deducted last year ($12,000 offsetting the capital gains and $3,000 as a net capital loss deduction). As a result, Aleshia would have to include all of the $8,000 received in gross income in the current year. 22. (LO 1) Bob has no bad debt deduction. Rather, he has income of $12,000 [$60,000 − $48,000 (basis in the account receivable; 60% × $80,000)].

23. (LO 2) It is possible to receive an ordinary loss deduction if the loss is sustained on small business stock (§ 1244 stock). Only individuals who acquired the stock from the corporation are eligible to receive ordinary loss treatment under § 1244. The ordinary loss treatment is limited to $50,000 ($100,000 for married individuals filing jointly) per year. Losses on § 1244 stock in excess of the statutory limits receive capital loss treatment. Therefore, Calvin’s total loss of $61,750 [$7,000 (amount realized) − $68,750 (adjusted basis)] is treated as follows: $50,000 is an ordinary loss, and the remaining $11,750 ($61,750 − $50,000) is a long-term capital loss. 24. (LO 4) The loss relates to a rental property (i.e., it is not a personal casualty loss). The amount of the loss is $600,000, the lesser of the decline in FMV $600,000 ($800,000 − $200,000) or basis of $650,000. Since the loss relates to a rental property, the loss will be a for AGI deduction. 25. (LO 4) For partial or complete destruction of personal use property, the loss is the lesser of the following: •

The adjusted basis of the property ($14,000).

•

The difference between the fair market value of the property before the event and the fair market value immediately after the event ($30,000).

As a result, Belinda’s loss is limited to $14,000. Any insurance recovery reduces the loss, so Belinda’s tentative loss is $4,000 ($14,000 – $10,000). Since this is a personal casualty loss and not related to a Federally declared disaster area, her $4,000 loss is not deductible. If, however, Belinda has other personal casualties in 2024 that generate a gain (or gains), she can use this $4,000 loss to reduce these gains (but not below zero). 26. (LO 4) A taxpayer who has both gains and losses for the taxable year must first net (offset) the personal casualty gains and personal casualty losses. If the gains exceed the losses, the gains and losses are treated as gains and losses from the sale of capital assets. The capital gains and losses are short term or long term depending on the period the taxpayer held each of the assets. In the netting process, personal casualty and theft gains and losses are not netted with the gains and losses on business and income-producing property. Tucker has a net casualty gain of $1,050 ($1,500 + $750 − $1,200). Therefore, he treats all of the gains and losses as capital gains and losses: Long-term capital loss (Asset 1); $1,200. Short-term capital gain (Asset 2); $750. Long-term capital gain (Asset 3); $1,500. Note: If personal casualty losses exceed personal casualty gains, all gains and losses are treated as ordinary items. The gains—and the losses to the extent of gains—are treated as ordinary income and ordinary loss in computing AGI. Losses in excess of gains are deducted as itemized deductions to the extent the losses exceed 10% of AGI, but only if the losses relate to a Federally declared disaster area.

27. (LO 5) Research and experimental expenditures incurred after December 31, 2021 must be capitalized and amortized. Amortization begins at the midpoint of the year the expenditures are paid or incurred, and the expenditures are amortized ratably over a five-year period. Sandstorm’s deductions for 2024 and 2025 are computed as follows: Research and Experimental Expenditures: $85,000 + $30,000 + $12,500 = $127,500. 2024 Deduction: [$127,500 ÷ 5 years] × ½ = $12,750. 2025 Deduction: $127,500 ÷ 5 years = $25,500. 28. (LO 6) Tim has an excess business loss of $65,000, computed as follows: Aggregate business deductions Less: Aggregate business gross income and gains Less: Threshold amount Excess business loss

$ 595,000 (225,000) (305,000) $ 65,000

So of Tim’s $370,000 proprietorship loss, $305,000 can be used to offset nonbusiness income. The $65,000 excess business loss cannot be used to offset nonbusiness income in the current year. Rather, it is treated as part of Tim’s net operating loss carryforward in subsequent years. 29. (LO 7) To arrive at the NOL for an individual, taxable income must be adjusted as follows: 1.

No deduction is allowed for personal and dependency exemptions (exemptions are also not allowed in computing taxable income from 2018 through 2025).

2. The NOL carryover from another year is not allowed in the computation of the current year’s NOL. 3. The qualified business income deduction (§ 199A) is not allowed. 4. Capital losses and nonbusiness deductions are limited in determining the current year’s NOL. a. The excess of nonbusiness capital losses over nonbusiness capital gains must be added back. b. The excess of nonbusiness deductions over the sum of nonbusiness income and net nonbusiness capital gains must be added back. A taxpayer who does not itemize deductions computes the excess of nonbusiness deductions over nonbusiness income by substituting the standard deduction for total itemized deductions. c. The excess of business capital losses over the sum of business capital gains and the excess of nonbusiness income and net nonbusiness capital gains over nonbusiness deductions must be added back. d. The add-back for net nonbusiness capital losses and excess business capital losses does not include net capital losses not included in the current-year computation of taxable income because of the capital loss limitation provisions.

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As a result, Valeria and Trey must add back $26,200 {$0 personal exemptions + $29,200 standard deduction − [$500 interest income + $2,500 ($4,800 − $2,300 net nonbusiness capital gains)]}. Note that in this example, there is no excess of nonbusiness capital losses over nonbusiness capital gains. 30. (LO 7) When an NOL is carried forward, the taxable income and income tax for the year is determined by including the NOL as a deduction for AGI. Several deductions (such as medical expenses and charitable contributions) are limited (based on the taxpayer’s AGI). These deductions must be recomputed on the basis of the new AGI after the NOL has been applied. Adjusted gross income (before 2024 NOL) Less: 2024 net operating loss* Adjusted gross income Itemized deductions (greater than standard deduction): Medical [$3,650 − (7.5% × $40,400)] Taxes Interest Taxable income

$48,200 (7,800) $40,400 $

620 6,100 11,000

(17,720) $22,680

*Taxable income ignoring the 2024 NOL is $31,065 (see text problem); 80% of taxable income is $24,852. Since the 2024 NOL ($7,800) is less than the 80% limitation, the entire 2024 NOL is allowed as a for AGI deduction in 2025.

PROBLEMS 31. (LO 1)

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040

January 29, 2025 Ms. Amy Westbrook 100 Tyler Lane Erie, PA 16563 Dear Amy: I am following up with you regarding your question about the possibility of taking a bad debt deduction on the loan you made to Sara Stuart. Your loan to Sara is a business bad debt; therefore, you are allowed to take a bad debt deduction for partial worthlessness. You will be able to take a bad debt deduction in the current year of $25,000 [($30,000 − $1,000) − $4,000]. Should you need more information or clarification, please contact me. Sincerely, Danielle A. Ross, CPA Partner

TAX FILE MEMORANDUM DATE:

January 29, 2025

FROM:

Danielle A. Ross

SUBJECT:

Bad Debt Deduction

Amy Westbrook’s $30,000 loan to Sara Stuart is a business bad debt. As a result, a bad debt deduction is allowed for partial worthlessness. Amy will be able to claim a bad debt deduction in the current year of $25,000 [($30,000 − $1,000) − $4,000]. 32. (LO 1) 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 $9,000 and taxable income of $45,000. Therefore, all of the $11,000 loss produced a tax benefit ($9,000 offsetting the capital gains and $2,000 as a net capital loss deduction). As a result, $10,000 would be included in Monty’s gross income this year. 33. (LO 1) Sally has no bad debt deduction. Sally has income of $5,000 ($65,000 − $60,000) because she collected more than her basis in the receivable. 34. (LO 1, 2) Salary § 1244 ordinary loss (limit of $100,000) Short-term capital gain on § 1244 stock $ 20,000 Short-term capital loss (nonbusiness bad debt) (19,000) Net short-term capital gain $ 1,000 Net long-term capital loss (remaining § 1244 loss) (5,000) Net capital loss (limited to $3,000; $1,000 LTCL carryover) Adjusted gross income

$120,000 (100,000)

(3,000) $ 17,000

35. (LO 2, 8) Sell all of the stock in the current year: Current year’s AGI Salary Ordinary loss (§ 1244 limit) Long-term capital gain $ 8,000 Long-term capital loss ($80,000 − $50,000) (30,000) Long-term capital loss (limited to $3,000; $19,000 LTCL carryover) AGI Next year’s AGI Salary Long-term capital gain Long-term capital loss carryover ($30,000 − $11,000) Long-term capital loss (limited to $3,000; $6,000 LTCL carryover) AGI

$ 10,000 (19,000)

Total AGI Current year Next year Total

$ 80,000 (50,000) (3,000) $ 27,000 $ 90,000 (3,000) $ 87,000 $ 27,000 87,000 $114,000

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

$ 80,000 (40,000) 8,000 $ 48,000

Next year’s AGI Salary Ordinary loss (§ 1244 stock) Long-term capital gain AGI

$ 90,000 (40,000) 10,000 $ 60,000

Total AGI Current year Next year Total

$ 48,000 60,000 $108,000

Abby’s combined AGI for the two years is lower if she sells half of her § 1244 stock this year and half next year. 36. (LO 3, 4, 8) The amount of the loss before the 10%-of-AGI limitation is computed as follows: Home ($350,000 − $290,000) Auto ($30,000 − $20,000) Total loss Less: $100 Loss before 10% of AGI

$60,000 10,000 $70,000 (100) $69,900

Because the President declared the area a Federal disaster area, Olaf and Anna could claim the loss on last year’s return (2023) or on the current year’s return (2024). Amount of loss on last year’s return: Loss Less: 10% of AGI (10% × $180,000) Total loss

$69,900 (18,000) $51,900

Amount of loss on current year’s return: Loss Less: 10% of AGI (10% × $300,000) Total loss

$69,900 (30,000) $39,900

If Olaf and Anna apply the loss to 2023, the benefit of the loss will be at a rate of 22% because taxable income will be $98,100 ($150,000 − $51,900) and the loss falls entirely within the 22% tax bracket. If the loss is applied to 2024, the benefit will be at a rate of 24% because taxable income will be $205,100 ($245,000 − $39,900) and the loss falls entirely within the 24% tax bracket. The tax savings will be $11,418 (22% × $51,900) if the loss is taken in 2023 and $9,576 (24% × $39,900) if the loss is taken in 2024. Therefore, Olaf and Anna should include the loss on their 2023 return because the tax savings is $1,842 ($11,418 − $9,576) greater. 37.

(LO 3, 4) 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

Personal Portion (60%) $480,000 (–0–) $480,000

$ 220,000* (240,000) ($ 20,000)

$420,000 (360,000) $ 60,000

Business contents loss Less: Insurance recovery Loss

$220,000 (175,000) $ 45,000

Personal casualty gain—contents ($65,000 insurance proceeds − $50,000 adjusted basis)

$ 15,000

Personal casualty loss—building

($ 60,000)

AGI before effects of accident Business gain—building Business loss—contents Personal casualty gain Personal casualty loss to extent of gain AGI

$100,000 20,000 (45,000) 15,000 (15,000) $ 75,000

Personal casualty loss—building ($60,000 − $15,000); $45,000 not deductible

–0–)

*Adjusted basis is less than the decline in FMV of $280,000 ($700,000 × 40%).

38. (LO 3, 4)

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040

February 24, 2025 Mr. Trevor Pickard 450 Colonel’s Way Warrensburg, MO 64093 Dear Trevor: 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

$12,000 (10,000) $ 2,000

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

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). 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, Jennifer Sampson, CPA Partner TAX FILE MEMORANDUM DATE:

February 24, 2025

FROM:

Jennifer Sampson

SUBJECT:

Tax consequences for Trevor Pickard if he does not file an insurance claim for reimbursement for damages to his business use car

If an insurance claim is filed, Trevor 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

$12,000 (10,000) $ 2,000

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

If no insurance claim is filed, Trevor will have a deductible loss of $10,000, which will reduce his tax liability by $3,500 (35% × $10,000); see Concept Summaries 7.3 and 7.4. In my correspondence with Trevor, I pointed out that the net cash benefit from filing an insurance reimbursement claim would be $7,800 ($11,300 − $3,500). 39. (LO 5) a. 2023 Salaries Materials Insurance Utilities Equipment depreciation Total research and experimental 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. 2024 Salaries Materials Insurance Utilities Equipment depreciation Total research and experimental expenses

$600,000 70,000 11,000 8,000 14,000 $703,000

Cost of inspection of materials for quality control ($6,000), advertising ($20,000), and promotion expenses ($18,000) are not research and experimental expenditures. b. Blue Corporation’s research and experimental expenditures total $619,000 in 2023 and $703,000 in 2024. Blue will amortize both sets of expenses over a five-year period beginning at the midpoint of the year the expenses are incurred (in this case, July 1 of 2023 or 2024); the year benefits will be realized does not matter. Blue’s deduction for research and experimental expenditures in 2023 and 2024 is computed as follows: 2023 Taxable Year 2023 expenditures [($619,000 ÷ 5 years) × ½ year]

$ 61,900

2024 Taxable Year 2023 expenditures ($619,000 ÷ 5 years) 2024 expenditures [($703,000 ÷ 5 years) × ½ year] Total research and experimental expenditures deduction

$123,800 70,300 $194,100

40. (LO 6) Leisel’s business loss is subject to the excess business loss rules. Her excess business loss is $17,000, computed as follows: Aggregate business deductions Less: Aggregate business gross income and gains Less: Threshold amount Excess business loss

$ 470,000 (148,000) (305,000) $ 17,000

So of Leisel’s $322,000 proprietorship loss, $305,000 can be used to offset nonbusiness income. The $17,000 excess business loss is treated as part of Leisel’s net operating loss carryfoward in subsequent years. As a result, none of the excess business loss can be used to offset other income that Leisel reports. 41. (LO 6) Each LLC member receives a Schedule K–1 from the LLC indicating a $320,000 ordinary loss; each will report this loss on their 2024 individual income tax return [on Form 1040 (Schedule E)]. Each contributed sufficient capital to absorb the loss. Timothy can use the full $320,000 loss in 2024 since it is less than the $610,000 excess business loss limitation threshold that applies to married taxpayers. Prada has an excess business loss of $15,000 ($320,000 less the $305,000 threshold for single taxpayers). This excess business loss is an NOL carryforward for Prada. 42. (LO 6) Josie and Zach’s excess business loss for 2023 is $272,000, computed as follows: Josie’s business loss Zach’s business loss Excess business loss threshold amount Excess business loss

$250,000 600,000 (578,000) $272,000

Thus, § 461(l) effectively limits Zach’s and Josie’s combined business losses of $850,000 to $578,000 for 2023. The $272,000 excess business loss is disallowed in 2023 and becomes a net operating loss carryforward to 2024. The $578,000 deductible loss in 2023 might also become part of their total 2023 net operating loss, depending on their other sources of income and deductions. See the completed Form 461 and Schedule 1 (Form 1040) for Zach and Josie for 2023.

43. (LO 7) a. Business receipts Less: Business expenses Net business loss Net capital gain Interest income Adjusted gross income Less: Itemized deductions (greater than Single standard deduction) Deduction for qualified business income* Taxable income

$144,000 (180,000) ($ 36,000) 22,000 3,000 ($ 11,000) (24,000) (–0–) ($ 35,000)

*Mario has no qualified business income in 2024. His business generated a loss of $36,000, and this loss will carry forward to future years and will reduce any qualified business income in those years. b. Taxable income Add: Excess of nonbusiness deductions ($24,000) over nonbusiness income ($3,000 + $22,000) NOL

($ 35,000) –0– ($ 35,000)

44. (LO 7) a. Business receipts $276,000 Less: Business expenses (320,000) Net business loss ($ 44,000) Salary 10,000 Ordinary nonbusiness income 8,000 Nonbusiness short-term capital gain $20,000 Nonbusiness long-term capital loss (9,000) Net short-term capital gain 11,000 Adjusted gross income ($ 15,000) Less: MFJ standard deduction (greater than $18,000 itemized deductions) (29,200) Deduction for qualified business income* (–0–) Taxable income ($ 44,200) Add: Excess of nonbusiness deductions over nonbusiness income and net nonbusiness capital gains [$29,200 − ($8,000 + $11,000)] 10,200 Net operating loss for 2024 ($ 34,000) *Xinran has no qualified business income in 2024. His business generated a loss of $44,000; this loss will carry forward to 2025 and will reduce any qualified business income in 2025. b. Due to the 80% of taxable income limitation on NOL carryforwards, a multistep process is required to determine Xinran’s 2025 taxable income: (1) determine taxable income before application of the NOL, (2) determine the NOL deduction, and (3) determine final taxable income.

(1) Determine taxable income before application of the NOL: Net business income Salary (spouse) Interest income Adjusted gross income Less: Itemized deductions (greater than MFJ standard deduction) Less: Deduction for qualified business income: Grocery store [$60,000 − $44,000 (2024 loss)] × 20%* Taxable income

$60,000 25,000 2,000 $87,000 (35,400) (3,200) $48,400

*Taxable income before the QBI deduction is $51,600 ($87,000 – $35,400); this is also modified taxable income. So the QBI deduction is not limited by the overall taxable income limitation (modified taxable income × 20%). (2) Determine the NOL deduction: The NOL deduction is limited to the lesser of: 1.

The NOL carryforward ($34,000).

2. 80% of taxable income computed in step 1: $38,720 ($48,400 × 80%). Because the NOL carryforward ($34,000) is less than the 80% limitation, all of the 2024 NOL is allowed as a for AGI deduction in 2025. (3) Determine final taxable income: Net business income Salary (spouse) Interest income NOL deduction Adjusted gross income Less: Itemized deductions: Charitable contributions (cash) of $35,000, limited to 60% of AGI $31,800 Medical expenses of $6,925, limited to the amount in excess of 7.5% of AGI ($6,925 − $3,975) 2,950 Less: Deduction for qualified business income: Grocery store [$60,000 − $44,000 (2024 loss)] × 20%* Taxable income

$60,000 25,000 2,000 (34,000) $53,000

(34,750) (3,200) $15,050

*Taxable income before the QBI deduction is $18,250 ($53,000 – $34,750); this is also modified taxable income. So the QBI deduction is not limited by the overall taxable income limitation (modified taxable income × 20%).

45. (LO 7) a. Business receipts Less: Business expenses Net business loss Interest income Salary Net capital gain Adjusted gross income Less: Standard deduction (greater than itemized deductions) Deduction for qualified business income* Taxable income

$400,000 (525,000) ($125,000) 8,000 50,000 4,000 ($ 63,000) (29,200) (–0–) ($ 92,200)

*Rick has no qualified business income in 2024. His business generated a loss of $125,000; this loss will carry forward to 2025 and will reduce any qualified business income in 2025. b. Taxable income ($ 92,200) Add: Excess of nonbusiness deductions over nonbusiness income and nonbusiness capital gains: Standard deduction $29,200 Less: Interest income (8,000) Capital gain (4,000) 17,200 Net operating loss ($ 75,000) c. The NOL can be carried forward indefinitely until used (subject to the 80% of taxable income limitation). d. Effectively, the $75,000 NOL is made up of the $125,000 business loss netted against Sara’s $50,000 salary. Because the NOL provisions apply solely to businessrelated losses, certain adjustments must be made so that the loss more closely resembles the taxpayer’s economic loss. When computing taxable income, individual taxpayers are allowed deductions for nonbusiness items (e.g., the standard deduction or itemized deductions that do not reflect actual businessrelated economic losses). Taxable income must be adjusted for these items (and, effectively, removed from the NOL calculation).

46. (LO 1, 2, 3, 4, 7) Salary State of Minnesota bond interest (Note 1) Ordinary § 1244 loss ($120,000 − $30,000) Capital gains and losses: 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) $70,000 Less: $100 floor (100) Less: 10% AGI floor (–0–) Total itemized deductions Taxable income (loss) Add: Excess of nonbusiness deductions over the sum of nonbusiness income plus net nonbusiness capital gains ($14,000 − $3,000) (Note 2) Net operating loss

$80,000 –0– (90,000) $18,000 (5,000) $13,000 (10,000)

3,000 ($ 7,000)

$14,000

69,900

(83,900) ($90,900)

11,000 ($79,900)

Notes (1)

The $40,000 of interest income from the State of Minnesota bonds is tax-exempt income.

(2)

For this purpose, the personal casualty loss is treated as a business loss (i.e., is not classified as a nonbusiness deduction).

TAX RETURN PROBLEMS 47. 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) Adjusted gross income Less: Itemized deductions Home mortgage interest $9,16 4 Charitable contributions 2,500 Sales taxes (Note 5) 1,289 Property taxes 3,200 Silverware loss: Lesser of adjusted basis of $14,000 or FMV of $15,000 $14,000 Less: Insurance proceeds (10,000) Less: $100 (100) $3,900 Auto: Lesser of decline in FMV ($7,000) or adjusted basis ($52,000) $ 7,000 Less: Insurance proceeds if claim filed (2,000) Less: $100 (100) 4,900 Total (Note 6) $8,800 –0– Total itemized deductions (greater than Single standard deduction) Less: Deduction for qualified business income (Note 7) Taxable income Tax on taxable income (from 2023 Tax Tables; Single) Less: Federal income tax withheld and estimated tax payments ($14,000 + $2,000) Net tax payable (or refund due) for 2023

$101,000 (4,580) 700 –0– –0– 100 10,000 (2,100) $105,120

(16,153) (–0–) $ 88,967 $ 14,882 ($

(16,000) 1,118)

Completed tax forms for this problem are available on the Cengage Instructor Center. Notes (1)

The $800 interest on the City of Boca Raton bonds is tax-exempt.

(2)

Life insurance proceeds of $60,000 payable as the result of the death of Denise’s sister are excludible from gross income.

(3)

The $5,000 gift from Denise’s aunt is excludible from gross income.

(4)

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.

(5)

For purposes of determining her sales tax deduction, Denise has $105,920 of income (including $800 of tax-exempt income). The IRS Sales Tax Calculator generates a $1,289 deduction; in addition to a 6% state sales tax rate, the city of Boca Raton has a 1% sales tax rate.

(6)

Since the theft loss and casualty loss did not occur as a result of a Federally declared disaster, neither is deductible.

(7)

Since Denise has no qualified business income, no deduction for qualified business income is allowed. The $4,580 business loss will carry over to 2024 and will offset any business income in 2024 (or future years), reducing the related deduction for qualified business income.

Part 2—Tax Planning Salary and bonus Gross receipts from business Less: Office rent $7,000 Supplies 4,840 Utilities and telephone 5,148 Wages 5,500 Payroll taxes 550 Equipment rentals 3,300 Net business income Interest income Alimony Less: Self-employment tax deduction* Adjusted gross income Less: Itemized deductions** Deduction for qualified business income*** [($7,662 − $542 self-employment tax deduction − $4,580 business loss from 2023) × 20%] Taxable income

$34,000

(26,338)

$101,000

7,662 700 10,000 (542) $118,820 (16,153) (508) $102,159

*Self-employment tax is $1,083 ($7,662 × 0.9235 × 15.3%); one-half of this amount is a for AGI deduction. See Chapter 12. **Greater than 2024 single standard deduction of $14,600. ***Taxable income before the QBI deduction is $102,667 ($118,820 – $16,153); this is also modified taxable income. So the QBI deduction is not limited by the overall taxable income limitation (modified taxable income × 20%). TAX FILE MEMORANDUM DATE:

January 10, 2024

FROM:

Julie Carson

SUBJECT:

Denise Lopez’s 2024 Tentative Computation of Taxable Income

Today I talked with Denise Lopez concerning her 2024 tax situation. Specifically, she wanted an estimate of her 2024 taxable income.

In addition to the gross receipts from her typing business increasing to $34,000 (from $20,000 in 2023), the following projections for 2024 were provided by Denise: (1) Items remaining unchanged from 2023: Salary Christmas bonus Itemized deductions Interest income Alimony Office rent expense

2023 $100,000 $ 1,000 $ 16,1 5 3 $ 700 $ 10,000 $ 7,000

2024 $100,000 $ 1,000 $ 16,1 5 3 $ 700 $ 10,000 $ 7,000

(2) Business expenses expected to increase by 10% from 2023 to 2024: Supplies Utilities and telephone Wages Payroll taxes Equipment rentals

$ $ $ $ $

2023 4,400 4,680 5,000 500 3,000

$ $ $ $ $

2024 4,840 5,148 5,500 550 3,300

(3) The following 2023 items will not recur in 2024: life insurance proceeds ($60,000), gift ($5,000), bingo winnings ($100), bad debt ($2,100), stolen silverware, auto accident. Based on this estimated information for 2024, her estimated 2024 taxable income was computed as follows: Salary and bonus Gross receipts from business Less: Office rent $7,000 Supplies 4,840 Utilities and telephone 5,148 Wages 5,500 Payroll taxes 550 Equipment rentals 3,300 Net business income Interest income Alimony Less: Self-employment tax deduction* Adjusted gross income Less: Itemized deductions** Deduction for qualified business income*** [($7,662 − $542 self-employment tax deduction – $4,580 business loss from 2023) × 20%] Taxable income

$34,000

(26,338)

$101,000

7,662 700 10,000 (542) $118,820 (16,153) (508) $102,159

48. Salary Rental income (including $6,000 rent collected from prior year; see Note 1) Less: Rental expenses Casualty loss on rental property Bad debt on uncollected rent (Note 2) Ordinary loss on § 1244 stock (Note 3) Short-term capital loss—limit (Note 4) AGI Less: Itemized deductions Personal casualty loss (not deductible; Note 5) Loss on investment property (painting) Other itemized deductions (Note 6) Less: Deduction for qualified business income (Note 7) Taxable income

$142,000 $66,000 (33,000)

Tax on $26,400 (Note 8) Income tax withholdings Net tax payable (or refund due) for 2024

33,000 (10,000) (–0–) (100,000) (3,000) $ 62,000 –0– (8,000) (23,000) (4,600) $ 26,400 $

2,704 (3,000) ($ 296)

Notes (1)

Rent collected from prior year must be included in gross income because Mason and Alyssa are cash basis taxpayers.

(2)

No bad debt deduction on uncollected rents can be taken because Mason and Alyssa are cash basis taxpayers.

(3)

The loss of up to $100,000 on the § 1244 stock is classified as ordinary loss.

(4)

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.

(5)

Because the personal casualty loss did not occur in a Federally declared disaster area, the loss is not deductible.

(6)

The combination of the investment casualty loss and other itemized deductions ($31,000; $8,000 + $23,000) is greater than the 2024 standard deduction for married taxpayers filing a joint return ($29,200).

(7)

In determining QBI, all deductions attributable to a trade or business are taken into account. This would include the casualty loss on the rental property. As a result, Mason and Alyssa’s QBI is $23,000 (their net rental income of $33,000 less the $10,000 deductible casualty loss). Their QBI deduction is $4,600 ($23,000 × 20%). Taxable income before the QBI deduction is $31,000 ($62,000 − $8,000 − $23,000); this is also their modified taxable income. So their QBI deduction is not limited by the overall taxable income limitation (modified taxable income × 20%).

(8)

Mason and Alyssa’s filing status is married filing jointly; their 2024 tax liability (based on the 2024 Tax Rate Schedules) is: Tax on $26,400: $2,320 + [($26,400 − $23,200) × 12%] = $2,704

RESEARCH PROBLEMS 1.

This fact pattern is similar to Clifford L. Brody, T.C. Summary Opinion, 2004–149. In this case, the petitioners were not allowed to claim their payment of the portion of the loan that they contend was the responsibility of the corporation as a bad debt deduction under § 166. The record indicated that the loan was a personal loan between the bank and petitioners and not a loan from petitioners to the corporation. In addition, it appeared likely that the corporation was capable of eventually paying its alleged share of the debt if necessary.

2. a. The key is to determine in which year the casualty was sustained. Reg. § 1.165–1(a) provides that a casualty or theft loss is deductible in the year the loss was “actually sustained” but does not clarify what “actually sustained” means. Thus, we look to case law for additional guidance. In Oregon Mesabi Corp., 39 BTA 1033 (1939), acq. 1944 C.B. 22, appeal dismissed, Comm. v. Oregon Mesabi Corp., 24 AFTR 458, 109 F.2d 1014, (CA– 9, 1940), fire killed trees in 1933. However, the timber was rendered worthless when attacked by insects and fungi in 1934 and 1935. The court determined that a loss deduction was not necessarily taken in the year of the fire, but in the years, as shown by the evidence, that worthlessness occurred. As a result, Esther’s loss is deductible in 2025, the year in which the trees died from disease. Despite the fact that the trees were weakened by the hurricane, they were not worthless until they died of disease. b. Student responses will vary. During the development process for the 2025 edition of this textbook, ChatGPT indicated that the casualty loss should be deducted in 2024, which is at odds with the conclusion reached using the Oregon Mesabi case. ChatGPT indicated that it did not have access to case law and, as a result, could not evaluate the case. Evolution of the tool may lead to correct results over time. This limitation would not exist with a law-specific AI tool (e.g., Thomson Reuters Checkpoint Edge).

RESEARCH PROBLEMS 3 TO 6 These research problems require that students utilize online resources to research and answer the questions. As a result, solutions may vary among students and courses. You should determine the skill and experience levels of the students before assigning these problems, coaching where necessary. Encourage students to use reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax professionals, academics, think tanks, and political outlets to research their answers. 3. Solutions may vary among students. 4. Students should be able to find multiple years of data (2020 being the most recent) at irs.gov/statistics/soi-tax-stats-individual-statistical-tables-by-size-of-adjustedgross-income#_grp2. The 2020 data file, containing information on all itemized deductions (including casualties), is 20in21id.xls. 5. Solutions may vary among students. 6. Solutions may vary among students. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHECK FIGURES 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36.

$8,000. No bad debt deduction; gain of $12,000. $50,000 ordinary loss; $11,750 long-term capital loss. $600,000. Not deductible. $1,050 personal casualty gain. 2024 $12,750; 2025 $25,500. $65,000. $26,200. $40,400; $22,680. In the year of partial worthlessness. Include $10,000 in gross income. No bad debt deduction; gain of $5,000. $17,000. Abby should sell half each year. $69,900 loss should be taken in prior year.

37. 38. 39.a. 39.b. 40. 41. 42. 43.a. 43.b. 44.a. 44.b. 45.a. 45.b. 45.c. 46. 47. 48.

AGI of $75,000; $0 itemized deduction. Net cash benefit of $7,800 of filing an insurance claim. 2023 $619,000; 2024 $703,000. 2023 $61,900; 2024 $194,100. $17,000. Timothy: None; Prada: $15,000. Excess business loss of $272,000. ($35,000). NOL of $35,000. NOL of $34,000. $15,050. ($92,200). NOL of $75,000. Carried forward indefinitely. $79,900. Refund for 2023 $1,118. Refund for 2024 $296.

SOLUTION TO ETHICS & EQUITY FEATURE Is Policy Cancellation an Escape Hatch? (p. 7-10). Code § 165(h)(4)(E), enacted in 1986, states that “[a]ny loss of an individual described in subsection (c)(3) to the extent covered by insurance shall be taken into account under this section only if the individual files a timely insurance claim with respect to such loss.” Prior to the enactment of § 165(h)(4)(E), a number of courts considered whether under § 165(a) a taxpayer’s election not to file an insurance claim for a loss precluded him or her from deducting the loss. In these cases, which involved casualty or theft losses, the IRS argued that the loss in question derived not from the casualty or theft itself, but from the taxpayer’s intervening decision not to file an insurance claim. It contended that as a result of the latter decision, the deduction did not correspond to a loss “sustained . . . and not compensated for by insurance or otherwise,” as required by § 165(a). See Rev.Rul. 78–141 (1978–1 C.B. 58). While this argument met some initial success [see, for example, Kentucky Utilities Co. v. Glenn, 68–1 USTC ¶9361, 21 AFTR 2d 1263, 394 F.2d 631 (CA–6)], ultimately it was soundly rejected by the courts—first by the specialized U.S. Tax Court and then by various appellate decisions affirming the decisions of that tax tribunal. See Miller v. Comm., 84–1 USTC ¶9451, 53 AFTR 2d 84–1252, 733 F.2d 399 (CA–6), aff’g, 42 TCM 665, T.C.Memo. 1981–431; Hills v. Comm., 82–2 USTC ¶9669, 50 AFTR 2d 82–6070, 691 F.2d 997 (CA–11), aff’g, 76 T.C. 484 (1981). In these cases, the taxpayers were allowed to deduct casualty losses under § 165 even though they failed to file insurance claims. In the Tax Reform Act of 1986, Congress intervened, denying a loss deduction under § 163(c)(3) for any loss covered by insurance unless “the individual files a timely insurance claim with respect to such loss.” Citing Hills and Miller, the accompanying House Committee Report noted that “[c]ertain courts have ruled that a taxpayer whose loss was covered by an insurance policy could nevertheless deduct the loss if the taxpayer decided not to file a claim under the terms of the insurance policy.” H.R. Rep. No. 99–426, at 658 (1985). It then continues with the following rationale for § 165(h)(4)(E): The deduction for personal casualty losses should be allowed only when a loss is attributable to damages to property that is caused by one of the specified types of casualties. Where the taxpayer has the right to receive insurance proceeds that would compensate for the loss, the loss suffered by the taxpayer is not damage to property caused by the casualty. Rather, the loss results from the taxpayer’s personal decision to forego [sic] making a claim against the insurance company. The committee believes that losses resulting from a personal decision of the taxpayer should not be deductible as a casualty loss. Under the bill, a taxpayer is not permitted to deduct a casualty loss for damages to property . . . unless the taxpayer files a timely insurance claim with respect to damages to that property. As a result, Noah’s casualty loss deduction will be disallowed by the IRS. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

SOLUTIONS TO BECKER CPA REVIEW QUESTIONS 1.

Choice “b” is correct. A married couple filing jointly can deduct up to $100,000 of worthless § 1244 stock as ordinary. Both of these stocks qualify based on the original capitalization. But Tinker does not qualify because Mark and Lucy were not original shareholders. So $100,000 of the $200,000 loss on Chance will qualify as an ordinary loss. Choice “a” is incorrect. The Chance stock does qualify as § 1244 stock, so part of the loss is ordinary. Choice “c” is incorrect. Although $200,000 is the full amount of the loss on Chance, which does qualify as worthless § 1244 stock, only a maximum of $100,000 qualifies as an ordinary loss. Choice “d” is incorrect. The $300,000 is the amount of the loss on Tinker, which does not qualify as worthless § 1244 stock because Mark and Lucy did not acquire the shares at the original issuance.

2. Choice “b” is correct. A married couple filing jointly can deduct up to $100,000 of worthless § 1244 stock as ordinary. Both of these stocks would qualify based on the original capitalization, but Tinker does not qualify because Mark and Lucy were not original shareholders. The $20,000 loss on Chance will qualify as an ordinary loss. Choice “a” is incorrect. Because the Chance stock qualifies under § 1244, the loss qualifies as worthless § 1244 stock. Choice “c” is incorrect. The $80,000 loss on Tinker does not qualify as worthless § 1244 stock because they purchased the shares after the original issuance. Choice “d” is incorrect. Although $100,000 is the maximum ordinary loss allowed for § 1244 stock, only the $20,000 of the loss on Chance qualifies under § 1244. 3. Choice “c” is correct. This is a loss on an involuntary conversion. The realized loss is $40,000 ($850,000 – $890,000). All losses on involuntary conversions are recognized. The basis of the new building is the $850,000 purchase price. Choices “a,” “b,” and “d” are incorrect, per the above explanation. 4. Choice “a” is correct. The starting point is the lesser of adjusted basis or decrease in FMV. Here, that is the $250,000 adjusted basis. The computation is then as follows: Smaller loss Insurance recovery Taxpayer’s loss Less: $100 Eligible loss 10% AGI limitation Deductible loss

$ 250,000 (200,000) $ 50,000 (100) $ 49,900 (10,000) $ 39,900

Choices “b,” “c,” and “d” are incorrect, per the above explanation.

5. Choice “c” is correct. Net operating losses occurring in tax years 2018, 2019, and 2020 can be carried back five years and carried forward indefinitely to offset taxable income in other years. Choices “a,” “b,” and “d” are incorrect based on the above explanation. 6. Choice “b” is correct. An NOL arising in a tax year after 2020 can be carried forward indefinitely but cannot be carried back. The NOL carryforward can only offset 80% of a future year’s taxable income. The future year’s taxable income is first reduced by 100% of any NOL carryforwards from pre-2018 tax years before calculating the 80% limitation amount, but this question provides that there are no NOL carryforwards from previous years. Choice “a” is incorrect. The post-2020 NOL can be carried forward indefinitely, but it can only offset 80% of a future year’s taxable income (reduced by 100% of any pre-2018 NOL carryforwards). Choice “c” is incorrect. An NOL arising in a tax year after 2020 can only be carried forward, not carried back. Choice “d” is incorrect. An NOL arising in a tax year after 2020 can only be carried forward, not carried back.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

Solution and Answer Guide

YOUNG, PERSELLIN, NELLEN, MALONEY, CUCCIA, LASSAR, CRIPE, SWFT COMPREHENSIVE VOLUME 2025, 9780357988817; CHAPTER 8: DEPRECIATION, COST RECOVERY, AMORTIZATION, AND DEPLETION

TABLE OF CONTENTS Discussion Questions...........................................................................................................1 Computational Exercises ................................................................................................... 3 Problems ............................................................................................................................. 6 Tax Return Problems ........................................................................................................ 19 Research Problems ........................................................................................................... 23 Check Figures.................................................................................................................... 26 Solution To Ethics & Equity Feature ................................................................................ 27 Solutions To Becker CPA Review Questions ................................................................... 27

DISCUSSION QUESTIONS 1.

(LO 1) Personal use property is any property (realty or personalty) that is held for personal use rather than for use in a trade or business or an income-producing activity. Cost recovery deductions are not allowed for personal use assets.

2. (LO 1) Personal property is any asset that is not real property. Personal use property is any property (realty or personalty) that is held for personal use rather than for use in a trade or business or an income-producing activity. 3. (LO 1) Land improvements have a MACRS class life of 15 years. Certain types of real property (e.g., land improvements) are cost recovered as MACRS personalty. 4. (LO 2) These are among the relevant issues for Henry: •

Can a portion of the purchase costs of a ski resort, which are allocated to the construction costs of the resort’s mountain roads, trails, and slopes, be depreciated?

•

If such costs can be depreciated, what is the correct recovery period?

•

Can costs incurred subsequent to the purchase, attributable to maintenance of such mountain roads, trails, and slopes, be depreciated?

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

5. (LO 2) The three factors the MACRS tables take into account are (1) recovery period, (2) method, and (3) convention. 6. (LO 2) The asset is treated as if it were placed in service in the middle of the quarter. The factors in the table take this into account; as a result, the cost of the asset is multiplied by the factor to determine the first year’s cost recovery. See Exhibit 8.4. 7. (LO 2) The asset is treated as if it were sold in the middle of the quarter; as a result, onehalf quarter of cost recovery is allowed in the quarter of the sale. If the sale is in the first quarter, the ratio is 0.5/4; in the second quarter, 1.5/4; in the third quarter, 2.5/4; and in the fourth quarter, 3.5/4. 8. (LO 2) Even if MACRS straight-line is elected for the 7-year class assets, the cost recovery on the 5-year class assets is computed using regular MACRS with a midquarter convention unless a separate election is made to use MACRS straight-line for the 5-year class assets (the mid-quarter convention also applies to the 7-year class assets). With respect to the mid-quarter convention, the assumption is made that Robert is a calendar year taxpayer. 9. (LO 3) Ordinary income recapture is required anytime property on which an expense has been taken under § 179 is converted to personal use (no longer used predominantly in a trade or business). 10. (LO 3) The basis of the property for cost recovery purposes is reduced by the § 179 amount [after it is adjusted for property placed in service in excess of the appropriate acquisition limit ($3,050,000 in 2024 and $2,890,000 in 2023)]. The business income limitation does not affect basis. 11. (LO 3) The § 179 amount eligible for expensing in a carryforward year is limited to the lesser of (1) the statutory dollar amount ($1,220,000 in 2024 and $1,160,000 in 2023) reduced by the cost of § 179 property placed in service in excess of the appropriate acquisition limit in the carryforward year ($3,050,000 for 2024 and $2,890,000 for 2023) or (2) the business income limitation in the carryforward year. 12. (LO 3) For § 179 purposes, business income is defined as the aggregate amount of taxable income of any trade or business of the taxpayer without regard to the amount expensed under § 179. Therefore, the taxable income computation for purposes of the § 179 limit includes the deduction for additional first-year depreciation and MACRS. 13. (LO 2, 3) The following issues are among those relevant to Jiaxu: •

Is Jiaxu entitled to a § 179 deduction?

•

How much, if any, can Jiaxu deduct under § 179 on his own tax return?

•

What are the tax consequences of the reimbursements that Jiaxu receives (including whether he received the reimbursement in the current year or the following year)?

14. (LO 4) The cost of listed property that does not pass the more-than-50% business usage test must be recovered using the straight-line method. If the listed property is an automobile, the cost recovery is further limited by the cost recovery limitations.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

15. (LO 4) The property is subject to cost recovery recapture, which is included in the taxpayer’s income tax return as ordinary income. The amount of the inclusion is the excess cost recovery, which is the excess of the cost recovery deduction taken in prior years using the statutory percentage method over the amount that would have been allowed if the straight-line method had been used since the property was placed in service. 16. (LO 7) The following tax issues are among those relevant for Orange Motors: •

Does the noncompete agreement come under § 197 for intangible assets?

•

Was the noncompete agreement in connection with the acquisition of a trade or business?

•

Can the cost of the noncompete agreement be amortized over a period other than the normal statutory period if the noncompete agreement is legally enforceable for a shorter period of time?

•

What is the statutory period for amortizing intangible assets?

17. (LO 4, 7) The following tax issues are among those relevant for Gwen: •

Are all of the expenditures qualifying expenditures?

•

Which of the expenditures must be capitalized?

•

Which of the expenditures will qualify for amortization under § 195?

•

What amount may be deducted under § 195 for 2024?

•

How will the acquisition cost of the assets be allocated to various classes of assets (e.g., equipment, building, land, and intangibles)?

•

Can Gwen use the immediate expense election (§ 179) and/or additional first-year (bonus) depreciation on any of the assets? If yes, should she?

18. (LO 8) The cost basis is divided by the estimated recoverable units of the asset to arrive at the depletion per unit. The depletion per unit then is multiplied by the number of units sold (not the units produced) during the year to arrive at the cost depletion allowed.

COMPUTATIONAL EXERCISES 19. (LO 2) The IRS provides tables that specify cost recovery allowances for personalty and for realty. To determine the amount of the cost recovery allowances, simply identify the asset by class and go to the appropriate table for the percentage (Exhibit 8.3). 2024

$80,000 × 0.1429 = $11,432.

2025

$80,000 × 0.2449 = $19,592.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

20. (LO 2) The mid-quarter convention applies if more than 40% of the value of property other than eligible real estate is placed in service during the last quarter of the year. Hamlet acquired 100% of assets in the last quarter of the year. Therefore, the midquarter convention applies (Exhibit 8.4). 2024

$100,000 × 0.0357 = $3,570.

2025

$100,000 × 0.2755 = $27,550.

21. (LO 2) The IRS provides tables that specify cost recovery allowances for personalty and for realty. Under MACRS, the cost recovery period for residential rental real estate is 27.5 years and the straight-line method is used for computing the cost recovery allowance. Nonresidential real estate uses a recovery period of 39 years; it also is depreciated using the straight-line method. Cost recovery is computed by multiplying the applicable rate by the cost recovery basis (Exhibit 8.8). a. Residential rental real estate: $1,000,000 × 0.03636 = $36,360. b. Nonresidential rental real estate: $1,000,000 × 0.02564 = $25,640. 22. (LO 2) The IRS provides tables that specify cost recovery allowances for personalty and for realty. The taxpayer may elect to use the straight-line method for depreciable personal property. The property is depreciated using the class life (recovery period) of the asset with a half-year convention or a mid-quarter convention, whichever applies. The election is available on a class-by-class and year-by-year basis (see Concept Summary 8.2). The percentages for the straight-line election with a half-year convention appear in Exhibit 8.5. 2024

$2,800 × 0.10 = $280.

2025

$2,800 × 0.20 = $560.

23. (LO 2, 3) Additional first-year depreciation is taken in the year in which the qualifying property is placed in service; it may be claimed in addition to the otherwise available depreciation deduction. After the additional first-year depreciation is calculated, the standard MACRS cost recovery allowance is calculated by multiplying the cost recovery basis (original cost recovery basis less additional first-year depreciation) by the percentage that reflects the applicable cost recovery method and convention. If the taxpayer had not elected additional first-year depreciation, the MACRS mid-quarter convention would have applied (the asset was purchased during the last quarter of the year and is the only asset purchased during the year). Diana’s deduction is: Additional first-year depreciation ($65,000 × 60%) MACRS cost recovery [($65,000 − $39,000) × 0.20 (Exhibit 8.3)] Total cost recovery deduction

$39,000 5,200 $44,200

24. (LO 3) a. In 2024, § 179 permits the taxpayer to elect to deduct up to $1,220,000 of the acquisition cost of tangible personal property used in a trade or business. Two additional limitations apply to the amount deductible under § 179. First, the ceiling amount on the deduction is reduced dollar for dollar when § 179

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

property placed in service during the taxable year exceeds a maximum amount ($3,050,000 in 2024). Second, the § 179 deduction cannot exceed the taxpayer’s trade or business taxable income, computed without regard to the § 179 amount. § 179 deduction before adjustment Less: Dollar limitation reduction ($212,000 < $3,050,000) Remaining § 179 deduction

$212,000 (–0–) $212,000

§ 179 deduction allowed due to business income limitation

§ 179 deduction carryforward ($212,000 − $5,600)

$206,400

5,600

b. Additional first-year depreciation is not limited to business income. As a result, McKenzie could use bonus depreciation to deduct $127,200 (60% of the $212,000) and use MACRS cost recovery on the remaining 40% [$84,800 × 0.1429 (Exhibit 8.3) = $12,118]. So total cost recovery would be $139,318 ($127,200 + $12,118). However, other limitations may apply (e.g., the excess business loss limitation; see text Section 7-5). 25. (LO 4) The law places special limitations on cost recovery deductions for passenger automobiles. The luxury auto limits are imposed before any percentage reduction for personal use. The cost recovery limitations are maximum amounts. If the regular MACRS calculation produces a lesser amount of cost recovery, the lesser amount is used. Year 2024

MACRS Amount $10,500 ($70,000 × 0.20 × 75%)

Recovery Limitation $9,300 ($12,400 × 75%)

Deduction Allowed $9,300

2025

$16,800 ($70,000 × 0.32 × 75%)

$14,850 ($19,800 × 75%)

$14,850

26. (LO 7) Taxpayers can claim an amortization deduction on intangible assets called “amortizable § 197 intangibles.” The amount of the deduction is determined by amortizing the adjusted basis of such intangibles ratably over a 15-year period beginning in the month in which the intangible is acquired. The 2024 § 197 amortization deduction of $7,250 ($1,000 + $6,250) is computed as follows: Patent: $60,000 ÷ 15 years = $4,000 × 3/12 = $1,000. Goodwill: $375,000 ÷ 15 years = $25,000 × 3/12 = $6,250. 27. (LO 8) Cost depletion is determined using the adjusted basis of the asset. The basis is divided by the estimated recoverable units of the asset (e.g., barrels and tons) to arrive at the depletion per unit. This amount is then multiplied by the number of units sold (not the units produced) during the year to arrive at the cost depletion allowed. Parscale’s depletion per ton is $16 ($8,000,000 adjusted basis ÷ 500,000 estimated recoverable tons). If 75,000 tons are sold this year, the cost depletion is $1,200,000 ($16 depletion per ton × 75,000 tons sold).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

28. (LO 8) Percentage depletion (also referred to as statutory depletion) uses a specified percentage provided by the Code. The percentage varies according to the type of mineral interest involved. The rate is applied to the gross income from the property, but in no event may percentage depletion exceed 50% of the taxable income from the property before the allowance for depletion. Gross income Less: Other expenses Taxable income before depletion

$340,000 (229,000) $1 1 1 , 000

Depletion allowance

$ 47,600*

*[The lesser of $47,600 (14% × $340,000) or $55,500 (50% × $111,000)].

PROBLEMS 29. (LO 1, 2) Cost of asset Less: Greater of allowed or allowable cost recovery: 2022 2023 Basis at the end of 2023 Less: Cost recovery for 2024 ($200,000 × 0.03636 × 0.5/12) Basis on date of sale

$200,000 $

910 7,272

Loss on sale of asset ($180,000 − $191,515)

(8,182) $1 9 1 , 8 1 8 (303) $1 9 1 , 5 1 5 ($

11,515)

30. (LO 1, 2) José’s basis for cost recovery is $300,000 because the basis of the house at the date of the conversion from personal use to rental property ($300,000) is less than the $400,000 fair market value. The cost recovery is $8,637 [$300,000 × 0.02879 (Exhibit 8.8)]. 31. (LO 2, 3) a. The office furniture (7-year class property) qualifies for additional first-year depreciation. As a result, 60% of the $130,000 cost can be deducted as additional first-year depreciation, with MACRS used to cost recover the remaining 40% of the cost: Additional first-year depreciation ($130,000 × 60%) MACRS cost recovery [($130,000 − $78,000) × 0.1429 (Exhibit 8.3)] Total cost recovery deduction

$ 78,000 7,431 $ 85,431

b. Immediate expense deduction under § 179 MACRS cost recovery [($130,000 − $52,000) × 0.1429 (Exhibit 8.3)] Total cost recovery

$ 52,000 1 1,146 $ 63,146

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

32. (LO 2) a. 2024 MACRS cost recovery ($200,000 × 0.20) (Exhibit 8.3)

$40,000

b. 2025 MACRS cost recovery [$200,000 × 0.32 (Exhibit 8.3) × ½]

$32,000

33. (LO 2) The mid-quarter convention must be used because the cost of the computers acquired in the fourth quarter exceeds 40% of the cost of all of the personal property acquired during the year ($70,000 ÷ $150,000 = 47%). Furniture (7-year class property) MACRS cost recovery [$40,000 × 0.1785 (Exhibit 8.4)] Trucks (5-year class property) MACRS cost recovery [$40,000 × 0.15 (Exhibit 8.4)] Computers (5-year class property) MACRS cost recovery [$70,000 × 0.05 (Exhibit 8.4)] Total cost recovery

$ 7,140 6,000 3,500 $16,640

34. (LO 2) a. The building was placed in service in October. 2024

$3,800,000 × 0.00535 (Exhibit 8.8) = $20,330

b. 2028 $3,800,000 × 0.02564 (Exhibit 8.8) × 6.5/12 = $52,776 35. (LO 2) The building meets the 80% gross receipts from dwelling units test. Therefore, it is classified as residential real property. The building’s depreciable basis is $1,500,000 [$2,000,000 (cost) − $500,000 (land)]. $1,500,000 × 0.02576 (Exhibit 8.8) = $38,640 36. (LO 2) Hotels are nonresidential real property. 2024

$10,800,000 × 0.01605 (Exhibit 8.8) = $173,340

2034

$10,800,000 × 0.02564 (Exhibit 8.8) = $276,912

37. (LO 2) The building’s depreciable basis is $1,300,000 [$1,600,000 (cost) − $300,000 (land)]. a. 2024

$1,300,000 × 0.0197 (Exhibit 8.8) = $25,610

b. 2030

$1,300,000 × 0.03636 (Exhibit 8.8) × 10.5/12 = $41,360

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

38. (LO 2, 3, 9) a. 5-year class property Immediate expense deduction under § 179 7-year class property Immediate expense deduction under § 179 ($520,000 − $200,000) MACRS cost recovery [($420,000 − $320,000) × 0.1429] Total deduction

$200,000

320,000 14,290 $534,290

b. 7-year class property Immediate expense deduction under § 179 5-year class property Immediate expense deduction under § 179 MACRS cost recovery [($200,000 − $100,000) × 0.20] Total deduction

$420,000 100,000 20,000 $540,000

c. The deduction for the year would be $5,710 larger ($540,000 − $534,290) if § 179 expense was first allocated to the 7-year class property (i.e., the longer-lived asset). Therefore, she should elect to expense the 7-year property (the furniture) first. d. The present value of the tax savings is $146,491. Year 1 2 3 4 5 6 7 8 Total

5-Year Asset $120,000 32,000 19,200 11,520 11,520 5,760

$200,000

7-Year Asset $420,000 0 0 0 0 0 0 0 $420,000

Total $540,000 32,000 19,200 11,520 11,520 5,760 0 0 $620,000

Tax Savings (@ 24%) $129,600 7,680 4,608 2,765 2,765 1,382 0 0 $148,800

NPV

$146,490.76

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

e. If Lori chooses not to use the § 179 expense election, the present value of the tax savings generated from using MACRS deductions is $130,520. Since the present value of the tax savings from using the § 179 deduction on the 7-year asset is $15,971 greater ($146,491 less $130,520), Lori should expense the 7-year asset. Year 1 2 3 4 5 6 7 8 Total f.

5-Year Asset $ 40,000 64,000 38,400 23,040 23,040 11,520 $200,000

7-Year Asset $ 60,018 102,858 73,458 52,458 37,506 37,464 37,506 18,732 $420,000

Total $100,018 166,858 111,858 75,498 60,546 48,984 37,506 18,732 $620,000

Tax Savings (@ 24%) $ 24,004 40,046 26,846 18,120 14,531 11,756 9,001 4,496 $148,800

NPV

$130,520.14

Here is a version of a spreadsheet (with formulas displayed):

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

39. (LO 2, 3) § 179 amount (less than $1,220,000 limit) Income limitation Income before § 179 and cost recovery Cost recovery ($95,000) Income before § 179 amount § 179 amount of $620,000 (limited to $155,000) Total deduction with respect to the 7-year assets in 2024 § 179 carryforward ($620,000 − $155,000)

$620,000 $250,000 (95,000) $155,000 $155,000 $465,000

Alternatively, Olga could choose not to elect § 179 on the equipment and use bonus depreciation to cost recover 60% of the assets ($372,000; $620,000 × 60%) and use MACRS to cost recover the remaining 40% of the assets’ cost [$248,000 × 0.1429 (Exhibit 8.3) = $35,439]. Total MACRS cost recovery would be $407,439; $372,000 + $35,439. However, this choice would result in a business loss, and the excess business loss rules might apply (see text Section 7-5). 40. (LO 2, 3, 9) a. 2023 § 179 expense (no business income limitation) MACRS cost recovery [($560,000 − $200,000) × 0.1429; Exhibit 8.3] Total deduction

$200,000 51,444 $251,444

2024 MACRS cost recovery [($560,000 − $200,000) × 0.2449; Exhibit 8.3] Total deduction

$ 88,164 $ 88,164

b. A completed Form 4562 (2023) appears on the following page.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

41. (LO 2, 4) The mid-quarter convention will limit Jonʼs cost recovery deduction (the car was the only asset purchased during the year and placed in service in the last quarter of the year). Cost Regular MACRS percentage (mid-quarter convention; Exhibit 8.4) Cost recovery (but subject to the § 280F limitation)

$38,000 × 5% $ 1,900

Cost recovery (less than § 280F limit of $12,400*) Less: Personal usage (20% × $1,900) MACRS cost recovery

$ 1,900 (380) $ 1,520

*The cost recovery limits are indexed annually. The 2024 amount is used. 42. (LO 4) 2023 MACRS cost recovery ($75,000 × 0.20) = $15,000 (limited to $12,200*)

$12,200

2024 ($75,000 × 0.32) = $24,000 (limited to $19,500*)

$19,500

*These cost recovery limits are indexed annually. Because the car was placed in service in 2023, cost recovery limitation amounts from 2023 are used. 43. (LO 2, 3, 4) a. Because the Acura has a GVW rating in excess of 6,000 pounds, it is not a passenger automobile and, as a result, is not subject to the luxury auto cost recovery limitations. However, because the vehicle is an SUV with a GVW between 6,000 and 14,000 pounds, the § 179 expense amount is limited to $30,500. § 179 expense MACRS cost recovery [($62,000 − $30,500) × 0.20; Exhibit 8.3] Total deduction

$30,500 6,300 $36,800

b. If Helen chooses to also use additional first-year depreciation on the SUV, then her total cost recovery deduction for 2024 would be $51,920, computed as follows: § 179 expense $30,500 Additional first-year depreciation [($62,000 − $30,500) × 60%] 1 8,900 MACRS cost recovery [($62,000 − $30,500 − $18,900) × 0.20 (Exhibit 8.3)] 2,520 Total cost recovery deduction $51,920

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

44. (LO 2, 4) Only business use percentages are used in determining whether the more-than-50% business use test applies (production of income and personal use percentages are ignored). However, both business and production of income use percentages are used for cost recovery purposes. Deduction for 2024 MACRS cost recovery ($68,000 × 0.20; Exhibit 8.3) = $13,600 (but limited to $12,400*) × 80%

$9,920

Deduction for 2025 Straight-line ($68,000 × 0.20; Exhibit 8.7) = $13,600 (not limited since less than $19,800*) × 70%

$9,520

Cost recovery recapture in 2025 (related to 2024) 2024 MACRS deduction 2024 Straight-line ($68,000 × 0.10) = $6,800 (not limited since less than $12,400*) × 80% Excess

$9,920 (5,440) $4,480

*These cost recovery limits are indexed annually. The 2024 amounts are used. 45. (LO 2, 4, 9) 100% business use [$4,000 × 0.20 (Exhibit 8.3)] × 100% 45% business use [$4,000 × 0.20 (Exhibit 8.3)] × 45% Reduced cost recovery if personal use occurs

$800 (360) $440

Tax cost ($440 × 32%)

$1 4 1

Note: A computer purchased after 2017 is not “listed property.” 46. (LO 2, 4, 9)

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040

December 20, 2023 Mr. Dennis Harding 150 Avenue I Memphis, TN 38112 Dear Mr. Harding: I am writing in response to your request concerning the tax consequences of purchasing versus leasing an automobile. Our calculations are based on the data you provided in our telephone conversation. If the automobile is purchased, the total cost recovery deductions for the five years will be $58,420. If the automobile is leased, lease payment deductions will total $56,700. In addition, you also must include $930 in your gross income.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

If you need additional information or clarification of our calculations, please contact us. Sincerely yours, Ishita J. Jones, CPA Partner TAX FILE MEMORANDUM DATE:

December 20, 2023

FROM:

Ishita J. Jones

SUBJECT:

Dennis Harding: Calculation of lease versus purchase

Facts Dennis Harding is considering purchasing or leasing an automobile on January 1, 2024. The purchase price of the automobile is $71,500. The lease payments for five years would be $945 per month. The inclusion dollar amounts for the next five years would be $62, $138, $204, $245, and $281. Dennis wants to know the effect on his adjusted gross income for purchasing versus leasing the automobile for five years. Calculations Purchase: Cost recovery deductions 2024 [$71,500 × 0.20 = $14,300 (limited to $12,400*)] 2025 [$71,500 × 0.32 = $22,880 (limited to $19,800*)] 2026 [$71,500 × 0.192 = $13,728 (limited to $11,900*)] 2027 [$71,500 × 0.1152 = $8,237 (limited to $7,160*)] 2028 [$71,500 × 0.1152 = $8,237 (limited to $7,160*)] Total cost recovery deductions

$12,400 19,800 11,900 7,160 7,160 $58,420

*These cost recovery limits are indexed annually. The 2024 amounts are used here. Lease: Lease payments ($945 × 60)

$56,700

Inclusion dollar amounts ($62 + $138 + $204 + $245 + $281)

930

47. (LO 2, 5) For regular income tax liability MACRS cost recovery ($16,000 × 0.20; Exhibit 8.3)

$ 3,200

For AMT liability ($16,000 × 0.15; Exhibit 8.6)

$ 2,400

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

48. (LO 2, 5, 9) a. Using ADS over the first three years generates $44,870 of depreciation (versus $56,270 using MACRS). The total tax cost of this difference is $3,648, and the PV of this tax cost is $3,464. Year

ADS

MACRS

Difference

Tax Cost (@ 32%)

PV Factor

PV of Tax Cost

$ 10,710

$14,290

($ 3,580)

($ 1,146)

1.0000

($ 1,146)

19,130

24,490

(5,360)

(1,715)

0.9434

(1,618)

15,030

17,490

(2,460)

(787)

0.8900

(700)

Total

$44,870

$56,270

($11,400)

($3,648)

($3,464)

b. Over the life of the asset, total depreciation is the same (and the overall tax cost or savings is zero). However, the present value of tax savings generated via ADS in the later years of the asset’s life is not sufficient to overcome the present value of the tax cost of this choice in the asset’s early years. Overall, the present value of the tax cost of using ADS (versus MACRS) is $788. PV Factor

PV of Tax (Cost) or Savings

ADS

MACRS

Difference

Tax (Cost) or Savings (@ 32%)

10,710

$ 14,290

($ 3,580)

($ 1,146)

1.0000

($ 1,146)

19,130

24,490

(5,360)

(1,715)

0.9434

(1,618)

15,030

17,490

(2,460)

(787)

0.8900

(700)

12,250

12,490

(240)

(77)

0.8396

(65)

12,250

8,930

3,320

1,062

0.7921

841

12,250

8,920

3,330

1,065

0.7473

796

12,250

8,930

3,320

1,062

0.7050

749

6,130

4,460

1,670

534

0.6651

355

$100,000

Year 1

Total

788)

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

Here is a version of a spreadsheet (with formulas displayed):

49. (LO 2, 7, 9)

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040

October 15, 2024 Mr. Mike Saxon 200 Rolling Hills Drive Shavertown, PA 18708 Dear Mr. Saxon: This letter is in response to your request concerning the tax consequences of allocating the purchase price of a business between the two assets purchased: a warehouse and goodwill. If the purchase price of $2,000,000 is allocated $1,200,000 to the warehouse and $800,000 to goodwill, the total recovery in the first year of operations will be $82,865. Cost recovery on the warehouse will be $29,532, and amortization of the goodwill will be $53,333. If the purchase price is allocated $1,500,000 to the warehouse and $500,000 to goodwill, the total recovery in the first year of operations will be $70,248. Cost recovery on the warehouse will be $36,915, and amortization of the goodwill will be $33,333. Therefore, under the first option, your deductions in the first year will be $12,617 greater ($82,865 − $70,248). The building is written off over 39 years, whereas the goodwill is written off over 15 years. Thus, the higher the allocation to goodwill, the faster the write-off. Should you need more information or clarification of calculations, please contact us. Sincerely yours, Janelle J. Jones, CPA Partner

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

TAX FILE MEMORANDUM DATE:

October 15, 2024

FROM:

Janelle J. Jones

SUBJECT:

Mike Saxon: Calculations of amount of recovery depending on the allocation of purchase price between a warehouse and goodwill

Facts: Mike is negotiating the purchase of a business. The final purchase price ($2,000,000) has been determined, but the allocation of the purchase price between a warehouse and goodwill is still subject to discussion. Two alternatives are being considered. The first alternative allocates $1,200,000 to the warehouse and $800,000 to goodwill. The second alternative allocates $1,500,000 to the warehouse and $500,000 to goodwill. Mike wants to know the total recovery during the first year of operation from each alternative. Calculations: Alternative 1 Warehouse [$1,200,000 × 0.02461 (Exhibit 8.8)]

$29,532

Goodwill ($800,000 ÷ 15 years) Total recovery

53,333 $82,865

Alternative 2 Warehouse [$1,500,000 × 0.02461 (Exhibit 8.8)]

$36,915

Goodwill ($500,000 ÷ 15 years) Total recovery

33,333 $70,248

Additional deductions in first year under Alternative 1 ($82,865 − $70,248)

$12,617

50. (LO 7) Deductible amount [$5,000 − ($64,000 − $50,000)]

–0–

Amortizable amount [($64,000 ÷ 180) × 10 months] Total deduction for startup expenditures

3,556 $ 3,556

51. (LO 7) Deductible amount [$5,000 − ($53,000* − $50,000)]

$ 2,000

Amortizable amount {[($53,000 − $2,000) ÷ 180] × 6 months} Total deduction for startup expenditures

1,700 $ 3,700

*Startup expenses do not include interest expense.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

52. (LO 8) Gross income Less: Expenses Taxable income before depletion

$12,000,000 (5,000,000) $ 7,000,000

Cost depletion [($10,000,000 ÷ 250,000) × 45,000] = $1,800,000 Percentage depletion (22% × $12,000,000 = $2,640,000, limited to 50% × $7,000,000 = $3,500,000) Taxable income

(2,640,000) $ 4,360,000

53. (LO 2, 9) Students will submit a variety of solutions. Here is one solution (along with formulas used).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

TAX RETURN PROBLEMS 54. Net income from Writers Anonymous (Note 1) Interest income Self-employment tax deduction (Note 4) Adjusted gross income Less: Itemized deductions (Note 2) Deduction for qualified business income (Note 5)

$ 27,500 4,000 (1,943) $ 29,557 (14,650) (2,981)

Taxable income

Tax on $11,926 from 2023 Tax Tables (Single) Self-employment tax (Note 4) Less: Estimated tax payments Net tax payable (or refund due) for 2023

11,926

1,2 1 1 3,886 (5,000) $ 97

Completed tax forms for this problem are available on the Cengage Instructor Center. Notes (1)

(2)

Income from sales Less: Rent Utilities Supplies Insurance Travel excluding meals ($3,500 − $1,200) Meals (50% limit applies; $1,200 × 50%) Depreciation and § 179 deduction (Note 3) Income from business

$95,000 $16,500 7,900 1,800 5,000 2,300 600 33,400

State income tax* Home mortgage interest Property taxes on home* Charitable contributions Total itemized deductions

(67,500) $27,500 $ 2,950 8,000 2,500 1,200 $14,650

*State income taxes are greater than state sales taxes; total state and local taxes are less than the $10,000 limit. Total itemized deductions exceed the standard deduction amount.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

(3)

Furniture and fixtures § 179 expense deduction Cost recovery ($21,000 − $21,000) × 0.1429 Computer equipment § 179 expense deduction Cost recovery ($12,400 − $12,400) × 0.2000 Total deduction

$21,000 –0– $12,400 –0–

$21,000

12,400 $33,400

All of the assets acquired by Janice can be expensed in 2023. If all assets cannot be expensed, the § 179 limited expensing election would be allocated to the longest-lived assets first. In this case, it would be associated first with the furniture and fixtures ($21,000) and then with the computer equipment ($12,400). The furniture and fixtures are 7-year MACRS assets; the computer equipment is a 5-year MACRS asset. (4)

The self-employment tax is calculated as follows (see Chapter 12): 1.

Net earnings from self-employment.

$27,500

2. Multiply line 1 by 92.35%.

25,396

3. If the amount on line 2 is $160,200 or less, multiply the line 2 amount by 15.3%. This is the self-employment tax.

$ 3,886

One-half of the self-employment tax, or $1,943, is a deduction for AGI. (5)

Janice’s qualified business income is $25,557 [her business net income ($27,500) less her self-employment tax deduction ($1,943)]. Her modified taxable income is $14,907 [AGI ($29,557) less itemized deductions ($14,650)]. Her qualified business income deduction is $2,981, the lesser of: 1.

20% of QBI ($25,557); 20% × $25,557 = $5,111.

2. 20% of modified taxable income ($14,907); 20% × $14,907 = $2,981. 55.

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 December 21, 2024 Mr. John Rivera 1045 Center Street Lindon, UT 84042 Dear Mr. Rivera: I am writing in response to your request concerning the effects on your 2024 adjusted gross income of selling IBM stock and using some of the proceeds to purchase an automobile to be used in your business. If you do not sell the stock and purchase the car, your adjusted gross income will be $136,000. If you sell the stock and purchase the BMW, your adjusted gross income will decrease to $130,600. The supporting calculations follow.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

No sale of stock and no purchase of car Fees for services Less: Business expenses Building rental Office furniture and equipment rental Office supplies Utilities Salaries ($34,000 + $42,000) Payroll taxes Fuel and oil Cost recovery (Note 3)

$912,000 $ 36,000 9,000 2,500 4,000 76,000 7,000 21,000 –0–

Total business expenses Business income before § 179 deduction Less: § 179 deduction (Note 1) Business income Interest income Dividend income Adjusted gross income

(155,500) $756,500 (640,000) $116,500 10,000 9,500 $136,000

Notes (1)

§ 179 deduction of $640,000 (in 2024, the maximum § 179 deduction is $1,220,000; since total acquisitions are less than $3,050,000, there is no reduction in the maximum § 179 deduction).

(2)

The inheritance of IBM stock worth $110,000 from Aunt Mildred is excludible under § 101.

(3)

Cost recovery (none; § 179 expense reduces MACRS basis to zero).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

Sale of stock and purchase of car Fees for services Less: Business expenses Building rental Office furniture and equipment rental Office supplies Utilities Salaries ($34,000 + $42,000) Payroll taxes Fuel and oil Cost recovery (Note 3) Car Total business expenses Business income before § 179 deduction Less: § 179 deduction (Note 1) Business income Interest income Dividend income Gain on stock sale (Note 2) Adjusted gross income

$912,000 $ 36,000 9,000 2,500 4,000 76,000 7,000 21,000 20,400 (175,900) $736,100 (640,000) $ 96,10 0 10,000 9,500 15,000 $130,600

Notes (1)

§ 179 deduction of $640,000 (in 2024, the maximum § 179 deduction is $1,220,000; since total acquisitions are less than $3,050,000, there is no reduction in the maximum § 179 deduction).

(2)

The inheritance of IBM stock worth $110,000 from Aunt Mildred is excludible under § 101. John’s recognized gain on the sale of the IBM stock is $15,000 ($125,000 amount realized − $110,000 adjusted basis) and is automatically classified as a long-term capital gain.

(3)

Cost recovery Car § 179 expense (100%; below overall maximum with other 2024 acquisitions) Total potential deduction Limited to ($12,400* + $8,000)

$75,000 $75,000 $20,400

*The cost recovery limits are indexed annually. The 2024 amounts are used. Should you want more information or need us to clarify our calculations, please contact us. Sincerely, Josita J. Sanchez, CPA Partner

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

RESEARCH PROBLEMS 1.

CLIENT LETTER SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 April 1, 2025 Ms. Cassandra Martin, CFO Dave’s Sport Shop 867 Broadway New York, NY 10003 Dear Ms. Martin: This letter is in response to your request to provide Dave’s Sport Shop with tax advice regarding the tax treatment of the inventory management software purchased in 2024. Generally, tax law provides that the cost of off-the-shelf software is recovered over 36 months, which would mean that the full cost of the software could not be deducted in the year of purchase. However, software is eligible for immediate expensing under § 179. In 2024, this provision allows for up to $1,220,000 of the cost of property other than real estate placed in service in the year to be immediately expensed. As long as Dave’s Sport Shop has not exceeded this limit with other property acquired in 2024 and expensed under § 179, the full cost of the software can be deducted under the provisions of § 179. Please let me know if your total acquisitions for the year exceeds this amount. If we can be of assistance in helping you to maximize your cost recovery deductions, please let me know. Sincerely, Gayle B. Anders, CPA Partner TAX FILE MEMORANDUM DATE:

March 30, 2025

FROM:

Gayle B. Anders

SUBJECT:

Amortization of software costs

Cassandra Martin, CFO of Dave’s Sport Shop, has requested that we provide tax advice regarding the immediate deduction of the cost of inventory management software purchased in the 2024 tax year. Per IRC § 167(f)(1), off-the-shelf software that has not been substantially modified is amortized over 36 months. (Note that software acquired as part of the purchase of a trade or business is an IRC § 197 intangible, subject to 15-year amortization. The client has not indicated that the software was acquired as a part of the acquisition of a business.)

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

However, software is eligible for immediate expensing under IRC § 179(d)(1)(A)(ii) as well as additional first-year depreciation under IRC § 168(k)(2)(A)(i)(II). As long as Dave’s has not exceeded the maximum § 179 limit in 2024 ($1,220,000) with other property acquired, the full cost of the software can be deducted in 2024. I did not mention the additional first-year depreciation provisions to the client. If acquisitions qualifying for § 179 exceed $1,220,000 for the year, I asked the client to contact us so that we can make her aware of this additional benefit. I have written Cassandra Martin and informed her of the amortization and § 179 provisions. 2. The facts of the case are similar to Chief Counsel Advice Memorandum 201234024, May 9, 2012. There, it was determined that a vineyard constituted § 179 property. As a result, taxpayers could elect to expense the costs incurred when the vineyard was planted on the current year’s income tax return. Therefore, Jed should be able to deduct the costs incurred in planting the vineyard in 2020 on his 2024 income tax return, assuming that all of the other requirements under § 179 have been satisfied. 3. The facts of the case are similar to Bruce Selig, 70 TCM 1125, T.C.Memo. 1995–519. In this case, the court ruled that a deduction was allowable. The Court found that over time, the exotic automobiles would, because of those exotic features, become obsolete in the petitioner’s business. The fact that petitioner failed to show the useful lives of the automobiles was irrelevant to the decision. The court found that the cars were not museum pieces that would have an indeterminable useful life.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

6. The referenced spreadsheets (2013 tax year, the most recent tax year for all entities as of our publication date) are available on the IRS Tax Statistics website. (1)

Corporate irs.gov/statistics/soi-tax-stats-returns-of-active-corporations-table-27 The 2013 tax year file: 13co27ccr.xls

(2)

Partnerships irs.gov/statistics/soi-tax-stats-partnership-statistics-by-sector-or-industry The 2013 tax year file: 13pa01.xls

(3)

Nonfarm Sole Proprietorships irs.gov/statistics/soi-tax-stats-nonfarm-sole-proprietorship-statistics The 2013 tax year file: 13sp01br.xls

7. Student responses will vary. In general, students will find that the current versions of the AI tools often provide incomplete or incorrect answers. Evolution of the AI tools may lead to more complete and accurate responses over time. During the development process for the 2025 edition, ChatGPT provided a correct response to Problem 32 and provided correct formulas for both parts of Problem 34 (but did not provide calculations). It did not provide a correct answer to Problem 38; its response provided information on how to calculate Lori’s MACRS cost recovery for the 5-year and 7-year asset, but then indicated that since “Lori is expensing the maximum amount under § 179, the choice of which asset to expense it on will depend on which scenario results in a higher total cost recovery deduction.”

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

CHECK FIGURES 19. 20. 21.a. 21.b. 22. 23. 24.a. 24.b. 25. 26. 27. 28. 29. 30. 31.a. 31.b. 32.a. 32.b. 33. 34.a. 34.b. 35. 36. 37.a. 37.b. 38.a. 38.b.

$11,432; $19,592. $3,570; $27,550. $36,360. $25,640. $280; $560. $44,200. $5,600; $206,400. $139,318. $9,300; $14,850. $7,250. $1,200,000. $47,600. Loss $11,515. $300,000 basis; $8,637 cost recovery. $85,431. $63,146. $40,000. $32,000. $16,640. $20,330. $52,776. $38,640. 2024: $173,340; 2034: $276,912. $25,610. $41,360. $534,290. $540,000.

38.d. 38.e. 39. 40.a. 41. 42. 43.a. 43.b. 44. 45. 47. 48.a. 48.b. 49. 50. 51. 52. 54. 55.

$146,491. $130,520. Cost recovery $155,000; § 179 carryforward $465,000. 2023: $251,444; 2024: $88,164. $1,520. $12,200 in 2023; $19,500 in 2024. $36,800. $51,920. Deduction in 2024 $9,920; deduction in 2025 $9,520; recapture in 2025 $4,480. $141. Regular tax deduction $3,200; AMT deduction $2,400. PV of tax cost is ($3,464). PV of tax cost is ($788). The first option produces a $12,617 greater deduction. $3,556. $3,700. $4,360,000 taxable income. Tax due for 2023 $97. AGI without purchase $136,000; AGI with stock sale and car purchase $130,600.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

SOLUTION TO ETHICS & EQUITY FEATURE Section 179 Limitation (p. 8-14). Joe can expense the cost of the truck under § 179. The income limitation is the aggregate amount of taxable income derived from the conduct of any trade or business. Although Joe reported a net operating loss from one business, the sale of his other business had a profit of $300,000. Therefore, taxable income is not a limitation.

SOLUTIONS TO BECKER CPA REVIEW QUESTIONS 1.

Choice “c” is correct. Equipment is personal property. When over 40% of depreciable property is placed in service in the last quarter of the year (as is the case here), the MACRS mid-quarter convention applies to personal property. Choice “a” is incorrect. After the maximum amount of § 179 depreciation (expense election) is taken, the remaining amount of property placed in service in the current year is depreciable using the regular tax depreciation rules. Because the maximum § 179 expense elected does not create or increase a net loss on Sima’s Schedule C, the entire § 179 expense elected can be deducted in the current year. There is no carryforward of the excess amount of purchases over the § 179 expense limit for the current year, as these may be depreciated under the regular tax rules. Choice “b” is incorrect. The MACRS half-year convention generally applies to personal property (including equipment); however, in this case, it does not apply, as all current year property (clearly over 40% of the total) was purchased in the last quarter of the year. Choice “d” is incorrect. Equipment is personal property. Real property is depreciated using the straight-line, mid-month convention.

2. The MACRS table for 5-year assets assumes 200% declining-balance depreciation with no salvage value and half-year convention. The calculation switches to straight-line when it is advantageous. This occurs in recovery year 4, when the expense for the remaining 2 ½ years accelerates the expense. Note that the year 4 and year 5 expense is calculated as the remaining $5,760 balance divided by 2 ½ remaining years ($5,760 ÷ 2.5 = $2,304). Also note that while the expense is calculated using the double declining-balance (or straight-line) method, the factor is calculated so that it can be applied to the original asset in-service amount (e.g., the original purchase price). Following is the calculation of the MACRS table factors for 5-year assets.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

Year of Asset’s Life

Best of DDB Rate or SL

Beg of Year Declined Balance

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

40% 40% 40% SL SL SL

$20,000 16,000 9,600 N/A N/A N/A

Half-Year Convention 0.5

0.5

Depreciation Expense Amount Balance $ 4,000 6,400 3,840 2,304 2,304 1,152 $20,000

$16,000 9,600 5,760 3,456 1,152 0

MACRS Factor

MACRS Factor Calculation

20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 100.00%

[$4,000 ÷ $20,000] [$6,400 ÷ $20,000] [$3,840 ÷ $20,000] [$2,304 ÷ $20,000] [$2,304 ÷ $20,000] [$1, 15 2 ÷ $20,000]

Choice “b” is correct. Per the calculations in the above table, the accumulated depreciation amount at December 31, year 10, using the MACRS 5-year tables is $10,400 [$4,000 + $6,400]. Note that the half-year convention is applied to the first and sixth years of the asset’s life. Note also that the full calculated depreciation amount ($4,000, assuming half-year convention) is allowed in the first year of the asset’s life. Choice “a” is incorrect. This calculation assumes straight-line with half-year convention in the first and last years of the asset’s life. Year 1 would be $2,000 ($20,000 ÷ 5 × 50%), and year 2 would be $4,000 ($20,000 ÷ 5). $2,000 + $4,000 = $6,000. Choice “c” is incorrect. This calculation assumes that the first year of depreciation started on April 1, year 9. Therefore, it applied the 200% declining-balance method to that year as a short year for depreciation ($6,000 depreciation for the year), calculated as follows: Depreciation Expense: Step 1: $20,000 × 40% = $8,000 Step 2: $8,000 ÷ 12 × 9 = $6,000 depreciation expense The second year of the asset’s life still applied the 200% declining-balance method (but there are no factors to use, so the standard calculation procedure is used). Depreciation Expense: Step 1: $20,000 − $6,000 = $14,000 declined balance after the first year Step 2: $14,000 × 40% = $5,600 depreciation expense for the second year Total Depreciation = $6,000 + $5,600 = $11,600

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

Choice “d” is incorrect. This answer option assumes that half-year convention was not applied in the first year, as follows: Year of Asset’s Life

Best of DDB Rate or SL

Beg of Year Declined Balance

Year 1 Year 2

40% 40%

$20,000 12,000

Half-Year Convention

Depreciation Expense Amount $ 8,000 4,800 $12,800

Balance $12,000 7,200

3. Choice “c” is correct. Both of these assets are personal property, and the general rule is to use the half-year convention. However, more than 40% of all personal property purchased occurred during the fourth quarter [$30,000 ÷ ($20,000 + $30,000) = 60%]. Therefore, all personal property purchased during the year must be depreciated using the mid-quarter convention. Choice “a” is incorrect. Mid-month is used only for real property, not personal property. Choice “b” is incorrect. Half-year is the general convention for personal property. But mid-quarter must be used because more than 40% of the purchases for the year took place in the fourth quarter. Choice “d” is incorrect. The full-year convention does not exist. 4. Choice “b” is correct. The office furniture is 7-year property. It was purchased in year 3, so that is recovery period 1. The MACRS depreciation for year 3 is $715 ($5,000 × 14.29%). Note that the half-year convention is built into the table. No adjustment is necessary. Choice “a” is incorrect. $500 would be correct if we used 10% for 10-year property. Choice “c” is incorrect. $875 would be correct if we used 17.49% for recovery period 3. Choice “d” is incorrect. $1,000 would be correct if we used 20% for 5-year property. 5. Choice “c” is correct. One-half month of depreciation is taken for the month that real property is disposed of. Choice “a” is incorrect. Real property is depreciated using the mid-month convention. Choice “b” is incorrect. Residential real estate is depreciated over a 27.5-year life. Choice “d” is incorrect. Salvage value is not considered in MACRS depreciation. 6. Choice “a” is correct. $1,000,000 × 0.03636 = $36,360. The (real) property is 27.5-year recovery property, and the recovery year is the 20th year. The depreciation rate is 0.03636, which is the straight-line rate for 27.5 years (1 ÷ 27.5 = 0.03636). Choices “b,” “c,” and “d” are incorrect based on the above calculation.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

7. Choice “c” is correct. The § 179 expense deduction is limited to taxable income for the year before the deduction. The amount of § 179 expense you can elect each year is also limited to a maximum annual allowance amount, which is phased out when the amount of qualifying property placed in service during the year exceeds a certain threshold amount. Choice “a” is incorrect. MACRS depreciation does not have a taxable income limitation, a maximum annual allowance amount, or an excess property phase-out. Choice “b” is incorrect. Straight-line depreciation does not have a taxable income limitation, a maximum annual allowance amount, or an excess property phase-out. Choice “d” is incorrect. First-year bonus depreciation does not have a taxable income limitation, a maximum annual allowance amount, or an excess property phaseout. 8. Choice “a” is correct. The § 179 deduction may not be taken if a loss exists. Choice “b” is incorrect. The § 179 deduction may be reduced based on total purchases. Choice “c” is incorrect. Real property is generally not eligible for the § 179 deduction. Choice “d” is incorrect. Corporations may elect to take the § 179 deduction. 9. Choice “d” is correct. Property, other than real property, is generally depreciated using the half-year convention unless the mid-quarter exception applies. The mid-quarter convention applies to all property, other than real property, if more than 40% of the total basis of such property is placed into service during the last three months of the tax year. Real property is depreciated using the mid-month convention. Choice “a” is incorrect. The equipment must use the mid-quarter convention because more than 40% of the personal property was placed into service in the last three months of the year. There is no such thing as the full-year convention. The building must use the mid-month convention, which is appropriate for all real property, not the half-year convention. Choice “b” is incorrect. The equipment must use the mid-quarter convention because more than 40% of the personal property was placed into service in the last three months of the year, not the half-year convention. Choice “c” is incorrect. The equipment must use the mid-quarter convention because more than 40% of the personal property was placed into service in the last three months of the year, not the half-year convention. The building must use the midmonth convention, which is appropriate for all real property, not the mid-quarter convention. 10. Choice “b” is correct. The maximum amount that can be expensed under § 179 in 2023 is $1,160,000, but that amount is reduced, dollar for dollar, for the amount the total qualified property placed into service in the year exceeds $2,890,000. In this case, the total amount of equipment placed into service is $3,630,000, and the excess purchases over the $2,890,000 threshold amount is $740,000. The maximum § 179 expense allowed of $1,160,000 is reduced by the $740,000 excess over the threshold. The reduced § 179 allowed is $420,000 ($1,160,000 – $740,000).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 8: Depreciation, Cost Recovery, Amortization, and Depletion

Choice “a” is incorrect. This is the amount of the reduction in the maximum § 179 allowed. Choice “c” is incorrect. The amount of qualified property that can be expensed is limited to the annual allowance amount, reduced by excess property placed in service for the year. Choice “d” is incorrect. This answer ignores that there is a reduction in the maximum amount allowed to be expensed for excess property placed in service during the year. 11. Choice “b” is correct. Patents Covenant not-to-compete Goodwill Total intangibles Amortization period Amortization

60,000 30,000 45,000 $ 135,000 ÷ 15 years $ 9,000

Note: For tax purposes, all intangible assets are amortized over 15 years. Choice “a” is incorrect. This answer only takes the patents and covenant not-tocompete into account. Goodwill is amortizable for tax purposes. Choice “c” is incorrect. This answer used a 10-year life for the patent ($60,000 ÷ 10 years = $6,000) and a 5-year life for the covenant ($30,000 ÷ 5 years = $6,000). In addition, this answer disregarded amortization of the goodwill. Choice “d” is incorrect. This answer used a 10-year life for the patent ($60,000 ÷ 10 years = $6,000) and a 5-year life for the covenant ($30,000 ÷ 5 years = $6,000). It also includes goodwill amortized over the proper 15 years ($45,000 ÷ 15 years = $3,000). 12. Choice “d” is correct. Real property includes land and all items permanently affixed to the land (e.g., buildings, paving, etc.). Choice “a” is incorrect. Real property includes more than just the land (as per the explanation above); it includes all items permanently affixed to land. Choice “b” is incorrect. “All” tangible property could include moveable personal property and is therefore, incorrect. Choice “c” is incorrect. “Intangible property in realized form” is a distracter and a contradiction in terms.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

Solution and Answer Guide

YOUNG, PERSELLIN, NELLEN, MALONEY, CUCCIA, LASSAR, CRIPE, SWFT COMPREHENSIVE VOLUME 2025, 9780357988817; CHAPTER 9: DEDUCTIONS: EMPLOYEE AND SELF-EMPLOYEDRELATED EXPENSES

TABLE OF CONTENTS Discussion Questions...........................................................................................................1 Computational Exercises ................................................................................................... 3 Problems ............................................................................................................................. 4 Tax Return Problems .......................................................................................................... 9 Research Problems ........................................................................................................... 14 Check Figures.....................................................................................................................17 Solution To Ethics & Equity Feature ................................................................................ 18 Solutions To Becker CPA Review Questions ................................................................... 18

DISCUSSION QUESTIONS 1.

(LO 1) As discussed in Concept Summary 9.1, a business must evaluate all factors when determining whether a worker is an employee or an independent contractor. No one factor controls, and no set number of factors “makes” the worker an employee or an independent contractor. Each of the factors identified, however, provides information in making this determination. a. More likely to be considered an employee. b. More likely to be considered an independent contractor. c. More likely to be considered an independent contractor. d. More likely to be considered an employee. e. More likely to be considered an employee. f.

More likely to be considered an employee.

2. (LO 2) It appears that Milton now works from home, which is considered his principal place of business. If the taxpayer has an office in the home that qualifies as a principal place of business, the transportation between home and various work locations becomes a deductible transportation expense (it is not a commuting expense).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

3. (LO 2) From the facts given, it appears that Emma has never claimed any deduction for the business use of the auto. Since she has already filed a tax return for 2022, an amended return claiming the deduction is appropriate. Due to an absence of records, Emma cannot use the actual cost method of determining the deduction. Consequently, the automatic mileage method should be chosen. Emma can prove the miles driven and the percentage of business use. 4. (LO 3) The main issue to be resolved is the location of Dr. Werner’s tax home. Presuming his salary to be more than modest, the tax home probably is the situs of Pelican University. Thus, Dr. Werner is in travel status when he conducts continuing education programs or testifies out of town. 5. (LO 4, 8) The cost of obtaining a master’s degree in quantitative finance for someone who already has an established financial planning practice is a deductible education expense. The taxpayer seems focused on improving her ability to serve her financial planning clients (and not moving into a new trade or business). 6. (LO 5) a. Neither the employee nor the employer is subject to the 50% limit. The award is compensation to the employee and is fully deductible by the employer. b. The employer is subject to the 50% limit. Under the TCJA of 2017, the costs of a subsidized eating facility are subject to the 50% limit rule from 2018 through 2025; the deduction for these costs will be eliminated beginning in 2026. c. Employer-paid recreational activities are not subject to the 50% limit. d. De minimis fringe benefits are not subject to the 50% limit. e. The 50% limit does not apply to business gifts. However, gifts are limited as to deductibility to $25 per donee per year. 7. (LO 5) a. The exclusive use requirement means that the office must be used solely for business purposes. However, an exception exists for licensed day-care businesses. b. Direct expenses benefit only the business part of the home and are deducted in full. Indirect expenses are for maintaining and operating the home and must be allocated between business and personal use. c. Employees can claim a deduction only if the office in the home is for the convenience of the employer. However, as an unreimbursed employee business expense, an employee gets no deduction for 2018 through 2025. Self-employed taxpayers classify the deduction as for AGI. d. If the residence is owned, an allocable portion of depreciation is allowed. If rented, an allocable portion of the rent can be claimed. e. The furnishings of the office are handled separately and are either expensed under § 179 or depreciated in accordance with the rules applicable to 5- or 7-year MACRS property (see Chapter 8). f.

The excess is carried over to the next year.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

8. (LO 5) The major advantage is simplicity. Less record keeping will be required, and only one computation is necessary. The disadvantages are that excess unused past losses cannot be used and that current excess losses cannot be carried forward. The major drawback is that the amount of the deduction is, in most cases, considerably less than that determined under the regular (actual cost) method. 9. (LO 6) a. Both types of plans allow a deduction for the amount contributed to the plan. Any income earned by the plan is not taxed. However, full taxation (i.e., both contributions and accumulated income) occurs when distributions take place. Keogh (H.R. 10) plans are limited to self-employed participants. b. Contributions to Roth IRAs are made with after-tax dollars. Unlike traditional deductible IRAs, therefore, no deduction is allowed for any contributions to the plan. Distributions from a Roth IRA are nontaxable, whereas those from traditional IRAs are taxed in full. 10. (LO 6) Joey, who is single, is eligible to make a $7,000 deductible contribution to a traditional IRA because he is not an active participant in a qualified plan. Alternatively, he is eligible to make a $4,667 ($7,000 − $2,333) contribution [($5,000 ÷ $15,000) × $7,000 = $2,333 deduction phaseout] to a Roth IRA. The phaseout for the contribution to a Roth does not start until AGI of $146,000, and the phaseout range is $15,000. 11. (LO 7) a. The reimbursements and expenses are omitted from the return. b. No reporting is required. Provided the other substantiation requirements are met, the amount of the expenses is deemed substantiated at the Federal per diem rate. c. All reimbursements are reported as additional wages (gross income), and the expenses are miscellaneous itemized deductions (which are not deductible from 2018 through 2025). In years prior to 2018, these expenses were deductible from AGI subject to the 2%-of-AGI floor.

COMPUTATIONAL EXERCISES 12. (LO 2) a. $6,030 (9,000 miles × $0.67). b. $140 (1,000 miles × $0.14). c. $105 (500 miles × $0.21). 13. (LO 3) The deductible expenses are $2,275 {$400 airfare + $375 meals [(5 days × $150) × 50% limit] + $1,500 lodging (5 × $300)}. 14. (LO 3) a. $1,050 (70% × $1,500). Because neither the seven-day nor 25% exception applies, the airfare must be apportioned. Travel days count as business days. As a result, the business percentage is 70% (7 days business/10 days total).

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Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

b. $700 [($200 × 7 business days, including 2 travel days) × 50% limit]. c. $2,000 ($400 × 5 days). 15. (LO 4) $0. The IRS has disallowed any costs that lead to qualifying for a different trade or business (in this case, practicing as a CPA or an attorney). However, the law school tuition would qualify for the lifetime learning credit (see text Section 12-4e). 16. (LO 5) $420 (50% of the meal costs and tips). 17. (LO 5) $350 (50% of the refreshments served during the event). The remaining expenses are entertainment and not deductible. 18. (LO 5) $290 [$25 (maximum cost allowed) + $4 (gift wrapping and shipping)] × 10 (number of gifts). 19. (LO 5) a. $1,138 {[($2,400 + $4,000 + $2,200) × 8%] + $450}. b. $1,000 [200 (square feet) × $5 (amount allowed)]. 20. (LO 8) $890; all of the expenses other than the gambling loss are miscellaneous itemized deductions subject to the 2%-of-AGI floor (and cannot be deducted from 2018 through 2025). The gambling loss remains deductible.

PROBLEMS 21. (LO 2) a. $7,090 {$140 + $200 + [90%($1,300 + $180 + $210 + $160 + $2,850 + $2,800)]}. Even though they are associated with business use, the fines of $320 are not deductible. b. $9,720 {[14,000 miles × $0.67 (automatic mileage rate for 2024)] + $140 + $200}. c. Keeping a written or electronic log of miles driven, the dates the automobile was used, the location of travel, and the business purpose is enough evidence for the standard rate method. If the actual expense method is used, keeping copies of receipts, canceled checks, and bills in addition to a mileage log is sufficient. Records and logs should be kept contemporaneously (e.g., updated weekly or daily). 22. (LO 2) a. Brent’s adjusted basis in the business portion of the auto is determined as follows: Depreciable business basis ($40,000 × 80%) Less depreciation (automatic mileage method; business portion): 2020 (8,000 miles × 27 cents) 2021 (19,000 miles × 26 cents) 2022 (20,000 miles × 26 cents) 2023 (15,000 miles × 28 cents) Adjusted business basis of auto on 1/1/24

$32,000 (2,16 0) (4,940 ) (5,200) (4,200) $15,500

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

b. Depreciable business basis ($40,000 × 80%) Less depreciation (allowed under actual operating cost method—see below*) Adjusted business basis of auto on 1/1/24

$32,000 (26,470) $ 5,530

*Depreciation allowed is the lesser of the MACRS amount (see Exhibit 8.3) or the recovery limitation (data provided in problem). Year MACRS Amount 2020 $40,000 × 20% × 80% = $6,400 2021 $40,000 × 32% × 80% = $10,240 2022 $40,000 × 19.2% × 80% = $6,144 2023 $40,000 × 11.52% × 80% = $3,686 Total depreciation allowed

Depreciation Allowed $ 6,400 10,240 6,144 3,686 $26,470

Recovery Limitation* $10,100 × 80% = $ 8,080 $16,100 × 80% = $12,880 $ 9,700 × 80% = $ 7,760 $ 5,760 × 80% = $ 4,608

23. (LO 3) a. Kristen’s assignment is temporary (not indefinite), so her tax home has not changed. While in Jackson, therefore, she is in travel status. The deductible portion of her weekend expenses is limited to $490, the amount she would have spent had she not gone home. The 50% limit will be applied to any meals. b. The answer will not change and remains $490, but for a different reason. A deduction is always limited to the amount actually spent. 24. (LO 3, 5) Although they may be very useful to his family, Enrique’s activities do not constitute a trade or business. Consequently, his expenses at the conference are not deductible. Denisse’s deductible expenses are as follows: Airfare (one ticket) Lodging ($250 × 3 days) Meals ($100 × 3 days × 50% limit) Registration fee ($620 − $120) Car rental Total

$1,000 750 150 500 300 $2,700

25. (LO 1, 3, 5) a. The travel expenses that are potentially deductible amount to $3,270: Airfare Lodging (5 nights) Meals (5 days): $900 ($180 × 5) × 50% limit Transportation Total

$1,500 1,200 450 120 $3,270

No allocation of the airfare is necessary since the trip was within the United States. The business portion of the meals ($900) is subject to the 50% limit. Because Kim is an employee, these expenses are miscellaneous itemized deductions and from 2018 through 2025 are not deductible. b. Kim would be allowed a $3,270 deduction for AGI. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

26. (LO 3) a. Justin’s trip is treated as being 100% for business. Weekends and holidays are business days when preceded and followed by business days. Foreign travel days are business days, and although not mentioned in the text, this should include days when travel is not possible (e.g., equipment failure, weather delays). b. Yes, because this causes Saturday, Sunday, and Monday to be nonbusiness days. c. Under the assumptions in part a., all of the airfare would be deductible. This is also the case regarding part b. because of the seven-days-or-less exception. Under the exception, the day of departure is not counted. Consequently, Justin’s trip lasted from Friday to Thursday, or seven days. 27. (LO 3) a. Thirteen days. Because travel days count as business and weekends count as business when preceding and succeeding days are business days, her entire absence is regarded as business. b. If Monica does not satisfy the seven-days or less-than-25% test, then part of her transportation cost is not deductible. c. Monica cannot satisfy the seven-days test because she was away from home for more than seven days. Under the less-than-25% test and not counting partial days, she could have vacationed for three more days assuming that the days did not interfere with the preceding and succeeding days’ provision. 28. (LO 5) $650 ($1,300 × 50%); although entertainment expenses are not deductible, the food and beverages served during the entertainment are deductible because they are purchased separately from the entertainment (and the 50% disallowance rule applies). 29. (LO 5) $119 ($25 + $28 + $25 + $41). No deduction is allowed for Darryl’s wife since the maximum gift allowed has already been used for Darryl (and Darryl’s wife is not in business). The gift to Darryl is $25 (maximum amount) + $3 (gift wrapping), or $28. The gifts to Haley and Veronica are deductible but limited to $25 (maximum amount). The lunch with Haley is deductible, but is subject to the 50% limit (so $41 is deductible). 30. (LO 5) a. The 2024 office in the home deduction is determined as follows: Real property taxes (20% × $3,600) Interest on home mortgage (20% × $3,800) Operating expenses on home (20% × $900) Allocated depreciation on home Total

$ 720 760 180 1,795 $3,455

In addition to the 2024 office in the home deduction of $3,455, Melanie can claim the $800 of unused home office deductions from the prior year. So in total, Melanie can claim an office in the home deduction of $4,255 ($3,455 + $800). The depreciation is determined as follows: 20% × [$350,000 (cost of residence) × 0.02564 (depreciation factor from Exhibit 8.8) = $1,795 (rounded)]. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

Because Melanie is self-employed as to her consulting activity, the expenses are deductions for AGI, reported on Schedule C. The real property taxes and interest not claimed, $2,880 ($3,600 − $720) and $3,040 ($3,800 − $760), respectively, qualify as itemized deductions from AGI. b. $1,500 under the Simplified Method. Although $5 per square foot is allowed and 400 square feet is involved—yielding $2,000 ($5 × 400)—the maximum allowed is $1,500 (300 square feet × $5 per square foot). Also, the unused deduction from the prior year ($800) cannot be used. Finally, the $500 not allowed ($2,000 − $1,500) in 2024 cannot be carried over to 2025. 31. (LO 5) a. The $600 residual (see part b) is an employee business expense and a miscellaneous itemized deduction. However, miscellaneous itemized deductions (including employee business expenses) are not deductible from 2018 through 2025. b. Since miscellaneous itemized deductions subject to the 2%-of-AGI floor are not allowed from 2018 through 2025, using the standard deduction has no effect on Christine’s taxable income. She can still claim the educator’s deduction of $300. Because she accounts to her employer, $500 of these expenses is offset by the reimbursement. The balance of $600 ($1,400 − $300 − $500) is nondeductible. 32. (LO 6) Govind may contribute a total of $14,000 to his IRA and a spousal IRA in 2024, with a maximum of $7,000 to either account. The $14,000 is deductible on their joint return. Alternatively, they can make the contributions to Roth IRA accounts instead of traditional accounts. Roth contributions are not tax deductible, but the amount contributed can be accessed after a five-year holding period. 33. (LO 6) Leo can contribute the lesser of $7,000 or 100% of his compensation for the year regardless of employer contributions to the SEP, because his AGI is less than $77,000. Leo may contribute $7,000 to a traditional IRA and take a deduction or contribute to a Roth IRA. 34. (LO 6) $162,000. Assuming that Jimmy met the income limitations at the time of his contributions, all of the funds may be withdrawn tax-free. He satisfies the five-year holding period for a Roth IRA and is over age 59 1/2 at the time of the distribution. 35. (LO 6) a. Carri and Dane both can contribute $7,000 ($14,000 combined) to their traditional IRA. b. Neither Carri nor Dane can deduct the contribution to a traditional IRA because their AGI exceeds the phaseout ceiling of $143,000. c. Carri and Dane cannot contribute to a Roth IRA since their AGI is in excess of the phaseout ceiling of $240,000. d. No deduction is available for a contribution to a Roth IRA. 36. (LO 6) a. and b. Gabriella and Dev each may contribute $7,000, for a total of $14,000. The spousal IRA provision enables a $7,000 contribution rather than a $5,500 contribution for Gabriella. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

37. (LO 6) a. The maximum amount for which Amber can elect § 401(k) plan salary deferral for 2024 is $23,000. b. Her tax liability for 2024 would be reduced by $5,520 ($23,000 × 24%) as a result of the salary deferral election. c. $23,000 maximum amount. The election of the maximum amount reduces Amber’s tax liability and maximizes her contribution to her retirement fund. d. To decide whether to contribute to a traditional or Roth § 401(k) account, Amber should predict her future tax rate when, if ever, she plans to take distributions. If her future tax rate is expected to be lower than 24% and she expects to take distributions during retirement, she should make contributions to a traditional account. If she expects her future tax rate to be 24% or higher, she should make her contributions to a Roth account. If she would like to leave the money in a tax deferred account as long as possible to be able to pass the funds to an heir, she should make her contributions to a Roth account. There are no RMDs from Roth accounts. 38. (LO 6) Shyam has elected to contribute $2,400 ($60,000 × 4%) to his SIMPLE § 401(k) plan. His employer will contribute $1,800 ($60,000 × 3%). Both amounts will vest immediately. 39. (LO 6) Harvey can contribute the actuarially determined amount required to provide a maximum benefit of $275,000 upon his retirement. Since his income from his practice is higher than this amount, the 2024 maximum benefit of $275,000 is the constraining amount. The older Harvey is, the higher the contribution will be since he is closer to retirement. 40. (LO 5, 7, 8, 9) It would be unwise for Ava to choose the $53,000 option due to the tax consequences involved. This option makes her subject to the 50% limit for business meals, along with the nondeductibility of any entertainment expenses. But even more significant is the fact that these expenses (employee business expenses) are miscellaneous itemized deductions, which are not allowed as a from AGI deduction from 2018 through 2025. If, on the other hand, Ava selects the $39,000 option, Gull Corporation will be subject to the 50% limit for business meals and nondeductibility of entertainment expenses. 41. (LO 1, 2, 5, 8) a. Not deductible. b. Not deductible. c. Not deductible. d. Not deductible. e. Deduction from AGI. f.

Not deductible.

Deduction for AGI.

h. Not deductible. i.

Not deductible.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

TAX RETURN PROBLEMS 42. Tax Computation Consulting practice (David) Consulting fees $145,000 Less: Business expenses (Note 6) (31,803) Earnings (Ella) Interest income (Note 1) Colorado bonds $ –0– IBM bonds 800 Wells Fargo Bank 1,200 Federal income tax refund (Note 2) Life insurance proceeds (Note 3) Inherited savings account (Note 4) One-half of self-employment taxes (Note 12) Sale of ATVs (Note 5) IRA contributions ($6,000 + $6,000) AGI Itemized deductions: Medical (Note 7) $ –0– Taxes (Note 8) Property ($6,400 − $960) 5,440 Income ($310 + $1,000 withheld + $2,000 estimates) 3,310 Interest (Note 9; $6,600 − $990) 5,610 Miscellaneous (Note 10) –0– Total itemized deductions $ 14,360

$113,1 97 42,000

2,000 –0– –0– –0– (7,997) –0– (12,000) $137,200

The Coles will use the Married, Filing Joint standard deduction since it is greater than their total itemized deductions

(27,700)

Deduction for qualified business income (Note 11) Taxable income

(21,040) $ 88,460

Tax on $88,460 using the 2023 Tax Tables (Married, Filing Jointly) Self-employment tax (Note 12)

$ 10,177 15,994 $ 26,17 1 (28,000) ($ 1,829)

Less: Federal tax withheld and estimated tax payments Net tax due (or refund)

Completed tax forms for this problem are available on the Cengage Instructor Center. Notes (1)

Under § 103, interest on state and local bonds is an exclusion.

(2)

Unlike state income tax refunds, Federal tax refunds are nontaxable.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

(3)

Life insurance proceeds are exclusions under § 101.

(4)

Inheritances are exclusions under § 102.

(5)

Because the Coles paid $14,000, the sale of the ATVs resulted in a $5,000 loss. Personal losses, however, are not deductible.

(6)

As a self-employed individual, David’s job expenses are deductions for AGI. They are listed below. Airfare Lodging Meals ($2,400 × 50%) Entertainment (not deductible) Transportation Business gifts ($25 × 18) Office supplies Business mileage (11,000 × $0.655) Business parking and tolls Office in the home [Percent of business use is 15% (450/3,000)]: Insurance ($2,600 × 15%) Repairs and maintenance ($900 × 15%) Utilities ($4,700 × 15%) Interest ($6,600 × 15%) Taxes ($6,400 × 15%) Painting, area rugs, and plants (in the office) Depreciation [$400,000 × 15% × 2.564% (rounded)]

$ 8,800 4,990 1,200 –0– 800 450 1,500 7,205 340 $ 390 135 705 990 960 1,800 1,538

6,518 $31,803

Note: David’s office in the home deduction under the Simplified Method would have been only $1,500 [300 square feet (maximum allowed) × $5 per square foot]. (7)

The Coles did not provide any information on medical expenses. Sarah’s funeral expenses are not deductible.

(8)

Property taxes of $960 have already been claimed as part of the office in the home deduction. State income taxes include the final amount of 2022 state income taxes paid in 2023 ($310) plus withholdings from Ella’s salary ($1,000) and estimated state tax payments ($2,000) in 2023.

(9)

Interest of $990 has already been claimed as part of the office in the home deduction.

(10)

Because Ella is an employee, her job-related expenses are miscellaneous itemized deductions (and not deductible in 2023).

(11)

Although David’s consulting practice is likely a “specified services” business, the Coles’ taxable income before the QBI deduction is less than where the phaseout limitations apply ($364,200 for married taxpayers filing a joint return in 2023). David’s QBI is $105,200 [the net income from his proprietorship ($113,197) less his self-employment tax deduction ($7,997)]. The Coles’ modified taxable income is taxable income before the QBI deduction less any net capital

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

gain. Their AGI is $137,200, and they will use the standard deduction ($27,700), so their modified taxable income is $109,500 ($137,200 − $27,700). As a result, the deduction for qualified business income is $21,040, the lesser of:

(12)

(1) 20% of qualified business income ($105,200 × 20%)

$ 2 1,040

(2) 20% of modified taxable income ($109,500 × 20%)

$ 2 1,900

David’s self-employment tax liability is 15.3% of his self-employment tax base. Schedule C net income

$113,197 × 0.9235 $104,537 × 15.3% $ 15,994

Self-employment tax base × Self-employment tax rate Self-employment tax

David is allowed a for AGI deduction for one-half of his self-employment taxes ($7,997; $15,994 × ½). 43. Salary (Note 1) Expense allowance (Note 2) Contribution to § 401(k) retirement plan (Note 3) Interest income (Note 4) Treasure trove (Note 5) Property transactions (Note 6): Loss on sale of lot Gain on boat Adjusted gross income

$83,000 –0– (11,000) 400 5,000 ($3,000) 1,500

Itemized deductions (exceed Single standard deduction): Medical (Note 7) $4,807 Sales tax (Note 8) 3,400 Charitable contributions (Note 9) 7,400 Campaign contribution (Note 10) –0– Premium on life insurance (Note 11) –0– Contribution to Coverdell education savings account (Note 12) –0– Taxable income Tax liability on taxable income of $60,293 using the 2024 Tax Rate Schedule for Single taxpayers is $8,317: [$5,426 + 22%($60,293 − $47,150)] Less: Withholding $8,400 Overpayment from 2023 500 Net tax due (or refund) for 2024

(1,500) $75,900

(15,607) $60,293

$ 8,317

(8,900) ($ 583)

Notes (1)

Gross income does not include the achievement award of $10,000 because it was not received in 2024. As a cash basis taxpayer, Saanvi does not recognize income until the year of its receipt.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

(2)

Because Saanvi is required to provide an adequate accounting to VITA, she keeps records of her various expenses and submits them to VITA for reimbursement (but not to exceed her allowance). Any excess expenses would be treated as employee business expenses (and miscellaneous itemized deductions). Expense allowance Expenses: Office in the home (Note 13) Business use of auto (Note 14) Employee expense—trip to Korea (Note 15) Other employee expenses (Note 16) Total expenses Expense allowance used Excess expenses

$30,000 $ 5,920 10,781 5,720 11,480

$33,901 (30,000) $ 3,901

Since Saanvi provided adequate accounting to her employer, the $30,000 expense allowance will effectively be offset by $30,000 of for AGI deductions. So VITA will not report the expense allowance to Saanvi as income. In addition, by providing an adequate accounting, any expense deductibility limitations (e.g., meals or entertainment) are shifted from Saanvi to VITA. Since Saanvi’s expenses exceeded her allowance, the excess expenses are miscellaneous itemized deductions (employee business expenses). However, miscellaneous itemized deductions are not deductible in 2024 because Congress suspended this deduction from 2018 through 2025. (3)

Most often these contributions are netted out from salary on the Form W–2 submitted by the employer [i.e., salary will be shown at $72,000 ($83,000 − $11,000)].

(4)

The $350 interest on the City of Tacoma bonds is not subject to tax.

(5)

The $5,000 in cash that Saanvi found (i.e., treasure trove) is income. See Exhibit 3.2 in Chapter 3.

(6)

Because gain on the sale of personal use property is taxed, Saanvi has a longterm capital gain of $1,500. When offset against a long-term capital loss of $3,000, the result is a net long-term capital loss of $1,500. The excess capital losses can be deducted against ordinary income.

(7)

Medical expenses paid Medical insurance premiums Total medical expenses Less limitation [7.5% × $75,900 (AGI)] Medical expense after limitation

(8)

The IRS sales tax tables did not have to be used because Saanvi could justify a larger amount.

(9)

Charitable contributions are deductible in the year paid. In this regard, it does not matter for which year they were pledged.

(10)

Political contributions are not deductible—to allow a deduction would violate public policy (see Chapter 6).

$ 6,000 4,500 $10,500 (5,693) $ 4,807

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

(11)

Premiums on personal life insurance policies are nondeductible. See Chapter 3, p. 3-7.

(12)

Contributions to Coverdell education savings accounts (CESAs) are nondeductible. However, distributions from CESAs are nontaxable exclusions from gross income. See Concept Summary 9.3.

(13)

Office in the home business use percentage is 20% (300 sq. ft. ÷ 1,500 sq. ft.). Indirect expenses are $18,000 (rent) + $4,000 (utilities) + $1,600 (insurance) = $23,600 × 20% (business use) = $4,720. Direct expense is $1,200 (carpeting). Total office in the home expense is $5,920 [$4,720 (indirect expense) + $1,200 (direct expense)].

(14)

Automobile expenses (actual cost method): Gasoline Depreciation Insurance Auto club dues Interest on car loan Repairs and maintenance Total Business percentage Business portion Plus: Business parking Total auto deduction

$ 3,100 7,104* 2,900 240 –0–** 1,200 $14,544 × 70% $10 , 1 8 1 600 $10,7 81

Traffic fines, even though incurred during business use, are not deductible. *Regular depreciation for automobiles (5-year MACRS property) would be $7,104 [$37,000 (cost) × 19.2% (third recovery year)]—see Exhibit 8.3 in Chapter 8. The third-year cost recovery limit for autos placed in service in 2022 is $10,800. As a result, the regular MACRS depreciation is used. **This deduction is available only to self-employed taxpayers (see p. 9-8). (15)

Trip to Korea (adequate accounting provided to VITA): Airfare*** ($3,600 × 50%) Lodging (7 nights × $300) Meals Transportation Total

$1,800 2,100 1,470 350 $5,720

***Because the exceptions do not apply, the airfare must be apportioned between business (50%) and personal (50%) time spent on the trip.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

(16)

Other employee expenses (adequate accountinig provided to VITA): Airfare Lodging Meals Transportation Business gifts**** Continuing education Professional journals Total

$ 4,10 0 3,200 2,800 300 540 400 140 $11,480

****The business gifts are allowed in full because the cost of gift wrapping and shipping can be added to the $25 maximum allowed.

RESEARCH PROBLEMS 1.

The facts involving Aaron are identical to those in Ronald E. Byers (94 TCM 438, T.C.Memo. 2007–331). In resolving employment status, the court applied the seven factors set forth in the Regulations. The results are described below with the name Aaron and Green replacing those involved in the Byers case. (1) Control over manner of accomplishing work. Aaron controlled the manner in which he arranged pickups and deliveries. (2) Investment in work facilities and tools. The cost of leasing the truck from Green was a significant investment by Aaron. (3) Opportunity for profit or loss. Aaron’s income depended on a percentage of the pickup and delivery income he generated. If such income exceeded his expenses (i.e., the charge for leasing the truck), he had a profit. If not, he had a loss. (4) Termination of work relationship. Under the agreement, Aaron had to give 30 days’ notice. In actual practice, however, he could quit anytime. (5) Participation in service integral to regular business. Truck drivers are an integral part of Green’s pickup and delivery service. (6) Length of relationship. A six-year period of performing services as a driver must be considered a long-term relationship. (7) Intent of the parties. At least as far as Green was concerned, its drivers were regarded as independent contractors. They not only were allowed to perform services for other parties but also were not treated as employees (e.g., no health or pension benefits, accrued vacation, or sick leave). Likewise, their earnings were reported using Form 1099 (rather than Form W–2). Items (1), (2), (3), and (7) are resolved in favor of the independent contractor status, and items (5) and (6) reflect employee classification. Item (4) was not resolved because immediate termination (the actual practice followed) reflects an employment arrangement, whereas an advance notice requirement (the condition specified in the operating agreement) indicates independent contractor status.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

Besides the seven criteria discussed above, the court in Byers noted that driving a delivery truck requires no special skills, which is not the case with most independent contractor situations. [But isn’t obtaining a commercial driver’s license a “special skill”?] Based on the facts as interpreted in Byers, Aaron is an independent contractor. Consequently, he owes self-employment taxes on his earnings from Green. Peno Trucking, Inc., where employee status was found, can be distinguished based on the following differences: •

The employer exercised significant control over the schedules of the drivers.

•

The trucks for use in the pickup and delivery services were provided (at no charge) to the drivers.

•

The right to terminate the services of the drivers immediately was unconditional.

2. Not necessarily. The IRS was not pleased with the outcome in Sutherland. The Service said that the provisions in § 274(e)(2) served to limit the deduction amount to the amount of income imputed by the taxpayer. However, the Tax Court interpreted the “to the extent of ” language in § 274(e) to mean that as long as amounts are imputed as income, the total amount of expenses was deductible. The IRS issued a limited acquiescence (via an AOD) to the Sutherland decision. However, that is no longer relevant because as a direct result of Sutherland, § 274(e)(2), on which Sutherland relies for a conclusion, was modified in 2004. Now for certain individuals (including the president and a 10% shareholder), the “to the extent” of language is changed so that the amount of expenses is limited to the amount included in income. However, for “nonspecified individuals,” the tax law is not changed and the total amount of expenses, irrespective of the amount of income imputed, can be deducted. As a result, the approach taken in Sutherland may be followed for employees other than the president or 10% shareholders. More generally, your client should apply the provisions in § 274(e)(2), Reg. § 1.274−2(f)(2)(iii), and Reg. § 1.274−12(c)(2), which distinguish between different types of employees.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

Collective: collective.com/blog/tax-tips/a-freelancers-guide-to-getting-taxes-right/ The Rideshare Guy: therideshareguy.com/rideshare-taxes/ H&R Block: hrblock.com/tax-center/guide-gig-worker-taxes/ TurboTax: turbotax.intuit.com/tax-tips/self-employment-taxes/a-freelancers-guide-totaxes/L6ACNfKVW 4. A variety of resources are available on the internet regarding NIL payments (including quite a few FAQs). Here are a few links: ncaa.org/sports/2021/2/8/about-taking-action.aspx tax.thomsonreuters.com/news/the-long-read-tax-implications-of-collegecollectives-nil-deals/ blog.turbotax.intuit.com/tax-planning-2/what-are-nil-rights-and-what-do-theymean-to-college-athletes-taxes-50930/ conductdetrimental.com/post/tax-season-faqs-for-nil-income goshockers.com/sports/2022/4/30/name-image-likeness FAQ.aspx policy.usc.edu/usc-athletics-student-athlete/ msuspartans.com/documents/2022/7/19/NIL_Policy_-_as_of_7.11.22.pdf 5. A variety of resources are available on the internet regarding Form 1099–K. Here are a few: IRS: irs.gov/businesses/understanding-your-1099-k Square: squareup.com/help/us/en/article/5048-1099-k-overview PayPal: paypal.com/webapps/mpp/irs6050w Stripe: support.stripe.com/questions/1099-k-forms-issued-by-stripe 6. According to the information on the form (obtained from irs.gov), Form 8919 is used to determine and report a taxpayer’s share of uncollected Social Security and Medicare taxes due on compensation if the taxpayer was an employee but was treated as an independent contractor by his or her employer.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

CHECK FIGURES 10. 12.a. 12.b. 12.c. 13. 14.a. 14.b. 14.c. 15. 16. 17. 18. 19.a. 19.b. 20. 21.a. 21.b. 22.a. 22.b. 23.a. 23.b. 24. 25.a. 25.b. 26.a. 27.a. 28. 29. 30.a.

$7,000 traditional IRA, or $4,667 Roth. $6,030. $140. $105. $2,275. $1,050. $700. $2,000. $0. $420. $350. $290. $1,138. $1,000. $890. $7,090. $9,720. $15,500. $5,530. $490. $490. $2,700. $0. $3,270; deduction for AGI. 100% business. 13 days. $650. $119. $4,255.

30.b. 31.a. 31.b. 32. 33. 34. 35.a. 35.b. 35.c. 35.d. 36. 37.a. 37.b. 37.c. 38. 39. 41.a. 41.b. 41.c. 41.d. 41.e. 41.f. 41.g. 41.h. 41.i. 42. 43.

$1,500. None. $300 deduction for AGI; $600 nondeductible. $14,000. $7,000. $162,000. $7,000 each. $0 deductible. $0. $0. $7,000 each ($14,000 total). $23,000. $5,520. $23,000. $4,200. Actuarially determined. Not deductible. Not deductible. Not deductible. Not deductible. Deduction from AGI. Not deductible. Deduction for AGI. Not deductible. Not deductible. Tax refund of $1,829 for 2023. Tax refund of $583 for 2024.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 9: Deductions: Employee and Self-Employed-Related Expenses

SOLUTION TO ETHICS & EQUITY FEATURE Your Turn or Mine? (p. 9-23). If the agent conducting the audit identifies the pattern (i.e., same participants, long-standing friendship, rotation of meal expense), any deduction claimed will be disallowed. The parties involved have used a form of reciprocal entertainment as a means of converting a nondeductible personal lunch into a deductible business meal. See Your Federal Income Tax (Publication 17), Chapter 26.

SOLUTIONS TO BECKER CPA REVIEW QUESTIONS 1.

Choice “a” is correct. Direct moving expenses (such as the costs to move the goods and the costs to move the taxpayer’s family from the old to the new location) are deductible as an adjustment before adjusted gross income, not as an itemized deduction. Temporary living expenses are not considered direct moving expenses. Choice “b” is incorrect. This amount ($1,200) would be the answer had the question asked for the adjustment for moving expenses. Choice “c” is incorrect. This option attempts to trick you into thinking there may be an allowable itemized deduction for temporary living expenses, but there is no such deduction. Choice “d” is incorrect. This option assumes both items of expense are itemized deductions, which is not the case.

2. Choice “d” is correct. They may each deduct the maximum amount of $7,000, which is a total of $14,000. Because Bob and Nancy are not active participants in another qualified plan, their deductible contribution is not phased out. Choice “a” is incorrect. $0 would be correct if they were phased out of the deduction, but there is no limitation here because neither Bob nor Nancy is an active participant in another qualified plan. Choice “b” is incorrect. $7,000 would be correct if only one of them were allowed to deduct the IRA contribution. They can both take the deduction. Choice “c” is incorrect. $11,200 would be correct if they were partially phased out of the deduction because Bob was an active participant in a plan and Nancy was not. There is no limitation here because neither Bob nor Nancy is an active participant in another qualified plan.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

Solution and Answer Guide

YOUNG, PERSELLIN, NELLEN, MALONEY, CUCCIA, LASSAR, CRIPE, SWFT COMPREHENSIVE VOLUME 2025, 9780357988817; CHAPTER 10: DEDUCTIONS AND LOSSES: CERTAIN ITEMIZED DEDUCTIONS

TABLE OF CONTENTS Discussion Questions...........................................................................................................1 Computational Exercises ................................................................................................... 4 Problems ............................................................................................................................. 5 Tax Return Problems .........................................................................................................13 Research Problems ............................................................................................................17 Check Figures.................................................................................................................... 20 Solution To Ethics & Equity Feature .................................................................................21 Solutions To Becker CPA Review Questions ....................................................................21

DISCUSSION QUESTIONS 1.

(LO 1, 2) Yes. Fifty percent of the business meals expenses in this situation are deductible for AGI, which is the base for determining the nondeductible portion of the medical expenses (i.e., 7.5% × AGI). A lower AGI may result in a larger medical expense deduction.

2. (LO 2) Cosmetic surgery is necessary (and therefore deductible) when it improves the effects of (1) a deformity arising from a congenital abnormality, (2) a personal injury, or (3) a disfiguring disease. Expenses incurred in connection with the restorative surgery (required as a result of the accident) are deductible because the surgery was necessary. Amounts paid for the unnecessary cosmetic surgery (reshaping the chin) are not deductible as a medical expense. 3. (LO 2, 8) The cost of care in a nursing home can be included in medical expenses if the primary reason for being in the home is to get medical care. Apparently the primary reason Jerry’s parents are in the nursing home is to get medical care, whereas medical care is not the primary reason Elaine’s parents are in the nursing home. Also, in computing the medical expense deduction, a taxpayer may include medical expenses for a spouse and for a person who was a dependent at the time the expenses were paid or incurred. Of the requirements that normally apply in determining dependency status, neither the gross income nor the joint return test applies in determining dependency status for medical expense deduction purposes. Elaine’s parents may not qualify as dependents for the medical expense deduction, while Jerry’s do qualify.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

4. (LO 2) Cheryl should consider the following tax issues: •

If she receives reimbursement in 2024, she must reduce her medical expense deduction by the amount of the reimbursement.

•

If she receives reimbursement in 2025, she is not required to reduce her 2024 medical expense deduction by the amount of the anticipated reimbursement.

•

If she receives the reimbursement in 2025 and deducted the expenses in 2024, she must include the reimbursement in gross income to the extent she received a tax benefit from the medical expense deduction in 2024.

•

She should consider her expected marginal tax rates for 2024 and 2025 and determine whether it is better to receive the reimbursement in 2024 or 2025.

5. (LO 2) David, who is self-employed, may deduct 100% of the premium of $7,500 as a deduction for AGI. Joan, who is an employee, may include the premiums of $8,000 she paid in computing her itemized deduction for medical expenses (subject to the 7.5%of-AGI floor). 6. (LO 2) Jayden, a calendar year taxpayer, paid $16,000 in medical expenses in 2024. Even if he expects $12,000 of these expenses to be reimbursed by an insurance company in 2025, he can include all $16,000 of the expenses in determining his medical expense deduction for 2024. He is not required to consider the potential reimbursement in computing his medical expense deduction for 2024. Casualty losses must be reduced if there is an expectation of reimbursement. Therefore, Jayden’s starting point in computing the casualty loss deduction is $6,000 ($20,000 loss − $14,000 expected reimbursement). Note also that, after determining the effects of the reimbursements and Jayden’s AGI, further reductions are required for the $100 floor (casualty loss) and the AGI floors (10% for the casualty loss and 7.5% for the medical expenses). 7. (LO 2) A Health Savings Account (HSA) plan requires that the taxpayer be covered by a high-deductible medical insurance policy, which means that the premiums on the policy will be less than those for a low-deductible policy. The contributions to the HSA are deductible for AGI, which reduces the nondeductible amount of itemized deductions subject to certain limitations, and the taxpayer does not have to itemize to obtain the deduction. The HSA distributions pay for the deductible medical expenses, and they are not included in gross income. Also, the income earned on the HSA is not included in gross income if it is used to pay medical expenses not covered by the highdeductible plan. 8. (LO 5, 8) Michaela can deduct mortgage interest on her principal residence and one of the two other residences. (The yacht is considered to be a residence as long as it has sleeping, bathroom, and cooking facilities.) She should choose the second residence that will result in the highest interest deduction. Her deduction is limited to interest on up to $750,000 of acquisition indebtedness (up to $1,000,000 if the debt existed at December 15, 2017).

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

9. (LO 5, 8) Many nontax issues (financial, investment, and personal) are involved in the Greggs’ decision, but this discussion will be limited to the tax issues. Interest on the loans will be deductible only to the extent the car is used for business purposes. The tax issue related to a possible sale of Bluebird stock concerns deductibility of the loss that will be incurred on the sale. If the Greggs have capital gains in excess of the loss, the entire loss can be offset against the gains. If they have no capital gains, they will be limited to a capital loss deduction of $3,000 in the year of sale, with excess capital losses being carried forward. It will also be necessary to determine whether the loss is long term or short term. There will also be tax issues related to depreciation on the car, but those issues are independent of the source of funding for the purchase. 10. (LO 5) No. Assuming that the car is used only for personal purposes, the interest on a loan to buy it is not deductible. 11. (LO 5) Points paid by a seller are treated as an adjustment to the selling price of the residence. The buyer is treated as having used cash to pay the points that were paid by the seller. The buyer may deduct the points if several conditions are met. These conditions are specified in Rev.Proc. 94–27. 12. (LO 6) Contributions are deductible only if made to a qualified charitable organization. The family would not qualify as a charitable organization, so Betty’s contribution will not be deductible. The church probably would be a qualified charitable organization. If so, Jack’s contribution will be deductible, assuming that he itemizes his deductions (instead of claiming the standard deduction). 13. (LO 6) Mike may be able to deduct a portion of the cost of the tickets. To the extent that tangible benefits are received, taxpayers are not allowed to deduct the cost of payments to charitable organizations. Mike will be required to reduce his deduction to the extent of the value of the dinner and the dance. This information will need to be provided by the public library. 14. (LO 6, 8) William should donate the $100,000 in the year he receives the $1,000,000 won in the state lottery. Deductions for cash donations to a qualified public charity (his church) are limited to 60% of adjusted gross income (AGI). His AGI in the year of receipt of the lottery winnings would be enough for him to take the entire contribution as a deduction in that year. If he donates the $100,000 in any other tax year, his deduction will be limited to $30,000 (60% × $50,000 AGI) plus or minus 60% of other income and adjustments on Form 1040 and Schedule 1 (Form 1040). William would be allowed to carry forward for five years the excess contribution not taken as a deduction in the year of contribution subject to the limitations.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

COMPUTATIONAL EXERCISES 15. (LO 2) Barbara may not include as medical expenses the following items that were incurred for the general improvement of her health: •

$840 dues at a health club incurred for the purpose of improving her general physical condition.

•

$240 for multiple vitamins and antioxidant vitamins.

She may include as medical expenses the $3,500 cost of the smoking cessation program but may not include the $250 cost of the nonprescription nicotine gum. Although the cost of nonprescription drugs is generally not deductible, the $2,600 spent on insulin is deductible. The funeral expenses of $7,200 do not qualify as medical expenses. Therefore, Barbara’s total qualified medical expenses are $6,100 ($3,500 + $2,600). Reducing this total by 7.5% of AGI ($4,050; 7.5% × $54,000) yields a medical expense deduction of $2,050 ($6,100 less $4,050). 16. (LO 3, 4) The $5,200 real estate tax Ramona pays is allocated between her and Tabitha based on the relative number of days each owns the property during the year. a. Therefore, $855 is allocated to Tabitha ($5,200 × 60/365) and $4,345 is allocated to Ramona ($5,200 − $855). Consequently, Tabitha may deduct $855 of real estate tax and Ramona may deduct $4,345. b. This calculation will also impact the basis in the real estate and the amount realized from the sale. Ramona’s basis in the real estate is $260,855 [$260,000 (purchase price) + $855 (property taxes paid by Ramona but allocated to Tabitha)]. Tabitha’s amount realized is $260,855 [$260,000 (sales price) + $855 (property taxes paid by Ramona but allocated to Tabitha)]. 17. (LO 4) Cash basis taxpayers deduct state income taxes in the year paid regardless of the year to which the payment relates and include refunds as income in the year received (subject to the tax benefit rule). a. $2,830 ($1,400 + $455 + $975). b. Pierre will have income of $630 in 2025 because the tax benefit rule applies. Pierre’s 2024 itemized deductions included state taxes of $2,830, and his itemized deductions ($17,650) exceeded his standard deduction by more than $630. So, he received a tax benefit of $630 in 2024 and must include the refund in income when received in 2025. 18. (LO 4) The refund will not be included as income in 2025 because Derek did not receive a tax benefit for the state income taxes paid in 2024 (i.e., Derek claimed the standard deduction). 19. (LO 5) Miller can deduct all of the interest on the $157,500 first mortgage because it is acquisition indebtedness. None of the interest on the $10,000 home equity loan is deductible because the loan proceeds were used for a personal purpose. Miller should apply the special 30-day tracing rule of Reg. § 1.163−15 to determine if the interest on the equity loan can be categorized as other than personal.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

20. (LO 6) The deduction for a contribution of capital gain property is based on its fair market value, and the deduction for a contribution of ordinary income property is equal to the lesser of the basis or the fair market value. a. Because Donna did not hold the stock for the long-term holding period (December 28, 2023, until September 10, 2024, is not “more than one year”), it is short-term capital gain property that is subject to the rules for ordinary income property. Therefore, her deduction is limited to $18,100. b. The deduction for a contribution of loss property (FMV is less than basis) is limited to the fair market value on the contribution date. Therefore, Donna’s deduction is $15,000. c. Donna needs to have documentation that the stock was donated (such as a letter from the charity), the date and the value at that date (such as from the trading data for the donation day). In addition, because the donation is $250 or more, she must have a contemporaneous written acknowledgment from the charity. 21. (LO 5, 8) Of the total payments associated with the home purchase during the first year of ownership, the qualified residence interest of $22,200 is an itemized deduction. The payment of principal is not deductible. Therefore, the after-tax cost in the first year is $16,296 {interest payments of $15,096 [$22,200 × (1 − 0.32)] + principal payments of $1,200}.

PROBLEMS 22. (LO 2) TAX FILE MEMORANDUM DATE:

February 27, 2025

FROM:

Sam Massey

SUBJECT:

Emma Doyle’s Medical Expense Deduction

Emma Doyle’s medical expense deduction is $10,825, determined as follows: Medical insurance premiums Doctor and dentist bills for Bob and April Doctor and dentist bills for Emma Prescription medicines for Emma Nonprescription insulin for Emma Total medical expenses Less: 7.5% of $75,000 (AGI) Deductible portion of medical expenses

$ 3,700 6,800 5,200 400 350 $16,450 (5,625) $10,825

Although Bob and April cannot be claimed as Emma’s dependents, they could have been had they not filed a joint return. Therefore, medical expenses incurred on their behalf qualify for the medical expense deduction. Insulin is an exception to the rule that nonprescription drugs do not qualify as medical expenses. The insurance recovery was not received until 2025. Therefore, it has no effect on the medical expense deduction for 2024.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

23. (LO 2) The amount that qualifies for the medical expense deduction is $14,900 ($11,000 + $2,200 + $1,700). The room and board for Lakeside qualifies because the move was motivated by Lawrence’s need for medical care. The cable TV fee is a personal expense. 24. (LO 2) Only $4,000 of the cost of the dust elimination system qualifies because $6,000 of the $10,000 cost of the system increased the value of Paul’s residence. The total medical expense is $9,700 ($4,000 dust elimination system + $450 additional operating costs + $4,500 doctor and hospital bills + $750 prescriptions). The $300 appraisal fee is a miscellaneous itemized deduction, not a medical expense (and not deductible currently). Therefore, Paul’s medical expense deduction is $5,950 [$9,700 − (7.5% × $50,000 AGI)]. 25. (LO 2) Self-employed persons can deduct 100% of their medical insurance premiums as a deduction for AGI. Thus, Giana may deduct $7,000 as a deduction for AGI in 2024. None of the amount is deductible as an itemized deduction. 26. (LO 2) The charges for tuition, room, and board paid to Red River Academy qualify because Beth receives specialized psychiatric treatment. Although Ed does not qualify as Susan’s dependent for purposes of claiming a dependency exemption, he qualifies as a dependent for medical expense purposes. All of the costs paid for Ed at Heartland Nursing Home are deductible because the primary reason he is there is to receive medical care. Prescription drugs and insulin are deductible, but nonprescription drugs are not. Only $4,300 of the filtration system qualifies because $2,200 of the $6,500 cost increased the value of Susan’s residence. The $700 increase in utility bills also is a medical expense. The appraisal fee of $360 is a miscellaneous itemized deduction (and not deductible currently). Deductible medical expenses are summarized below. Surgery for Beth Red River Academy charges for Beth: Tuition Room, board, and other expenses Psychiatric treatment Doctor bills for Ed Prescription drugs for Susan, Beth, and Ed Insulin for Ed Charges at Heartland Nursing Home for Ed: Medical care Lodging Meals Deductible cost for filtration system ($6,500 − $2,200) Increase in utility bills due to the system Total medical expenses (prior to the AGI floor)

$ 4,500 5,100 4,800 5,100 2,200 780 540 5,000 2,700 2,650 4,300 700 $38,370

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

27. (LO 2) The following tax issues are suggested by the facts presented: •

Can Rebecca claim Isabella as a dependent?

•

Can Rebecca take a medical expense deduction for the remodeling expenditures?

•

Can Rebecca take a medical expense deduction for the swimming pool expenditures?

•

Can Rebecca take a medical expense deduction for the cost of Isabella’s surgery?

•

Can Isabella take a medical expense deduction for the specially equipped van and the costs of operating it?

•

Can Rebecca take a medical expense deduction for the traveling expenses (transportation, highway tolls, meals, and lodging)?

•

Can Rebecca deduct the medical expenses incurred for Isabella if Isabella does not qualify as her dependent?

The following questions should be asked to resolve some of the issues listed above: •

Did Rebecca provide more than half of Isabella’s support? This will determine whether Rebecca can deduct Isabella’s medical expenses. In addition, Rebecca may be able to claim head-of-household filing status if Isabella lived with her for more than half the year.

•

Are the remodeling expenses necessary to enable Isabella to live independently? If so, the expenses are included in medical expenses subject to the AGI limitation.

•

Is the travel to Denver necessary for Isabella to receive proper medical treatment? If it is, the travel expenses are included in medical expenses subject to the AGI limitation.

•

How much expense did Rebecca incur for lodging? The deduction is limited to $50 per night per person.

28. (LO 2) a. Because Roger is self-employed, he can deduct the $3,000 paid for the highdeductible policy as a deduction for AGI. In addition, he may deduct the $2,600 paid to the HSA as a deduction for AGI. Thus, Roger may deduct $5,600 ($3,000 + $2,600) for AGI. b. The $3,000 paid for the high-deductible policy is included with other medical expenses subject to the AGI limitation (i.e., from AGI) unless the premiums are paid through an employer-sponsored plan (in which case they would reduce taxable salaries and wages). The $2,600 paid to the HSA is a deduction for AGI. 29. (LO 3, 4) Rick’s basis in the residence is $297,780 [$300,000 (purchase price) − $2,220 (property taxes allocated to Rick but paid by Alicia)].

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

30. (LO 4) In general, cash basis taxpayers deduct state income taxes in the year paid regardless of the year to which the payment relates and include refunds as income in the year received (subject to the tax benefit rule). a. $9,100 ($1,000 + $7,400 + $700). b. Nichole will have income of $1,800 in 2025 because the tax benefit rule applies. c. It will be treated as income in 2025. It’s treated as if she received the payment and then made a payment to the state. d. $0 will be included as income in 2025 because she did not receive a tax benefit in 2024. 31. (LO 5) Acquisition indebtedness is limited to $750,000, and only this amount of debt produces qualified residence interest. Amy may only deduct 93.75% ($750,000 debt limit ÷ $800,000) of the $12,000 interest paid as qualified residence interest. Amy’s qualified residence interest deduction is limited to $11,250 ($12,000 × 93.75%). 32. (LO 6) Generally, when a donor derives a tangible benefit from a contribution, he or she cannot deduct the value of the benefit. That is the case here. Nadia cannot deduct any portion of the $4,000 donation since it relates to getting preferred seating at an athletic event (here, football games). 33. (LO 6) In general, the deduction for a contribution of capital gain property is based on the fair market value, and the deduction for a contribution of ordinary income property is equal to the lesser of the basis or the fair market value. a. Liz did not hold the stock for more than a year (the required long-term holding period). Liz held the stock from December 3, 2023, until July 5, 2024, so it is shortterm capital gain property that is subject to the rules for ordinary income property. Therefore, her deduction is limited to $10,000 (her basis in the stock). b. Liz held the stock for more than a year (the required long-term holding period). Liz held the stock from July 1, 2021, until July 5, 2024, so it is capital gain property. Therefore, her deduction is equal to the fair market value of the stock, $17,000. c. The deduction for a contribution of loss property (FMV is less than basis) is limited to the fair market value. Therefore, Liz’s deduction is $7,500. 34. (LO 6, 8) a. The cash gift of $95,000 is fully deductible as a charitable contribution. Ramon’s deduction is limited to $108,000 (60% of $180,000 AGI). Thus, the entire amount is deductible in 2024. b. Ramon’s value for the contribution is $95,000, the fair market value of the stock. However, the 30% ceiling applies to contributions of appreciated capital gain property to 50% organizations. As a result, the deduction for 2024 is limited to $54,000 (30% of $180,000 AGI). The remaining $41,000 ($95,000 − $54,000) can be carried forward for five years and deducted in those years, subject to the same percentage limitations. c. In making a gift of capital gain property that also is tangible personalty, which is put to an unrelated use by the charity, the charitable contribution deduction is reduced by the amount of long-term capital gain that would have been recognized

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

had the property been sold for its fair market value. Therefore, the contribution is valued at $60,000 ($95,000 current value less the $35,000 long-term capital gain element). The amount is fully deductible in the current year because the gift is below the applicable 50% of AGI limitation. It would be wise for Ramon to find a charity willing to use the painting for its charitable purposes (e.g., an art museum); Ramon would then get a $95,000 charitable contribution deduction (fair market value). d. If Ramon makes the charitable contribution in 2024: Present Value of the Tax Savings Current Year Next Year Deduction (current year limitation = 60% of $180,000 AGI) $108,000 $ 5,000 Tax rate × 24% × 32% Tax savings $ 25,920 $ 1,600 Present value factor × 1.0000 ×0.9434 Present value of tax savings $ 25,920 $ 1,509 Total present value of tax savings from the tax deduction ($25,920 + $1,509) $ 27,429 If Ramon makes the charitable contribution in 2025: Present Value of the Tax Savings Next Year Deduction (60% of AGI limitation does not apply) $113,000 Tax rate × 32% Tax savings $ 36,160 Present value factor × 0.9434 Total present value of tax savings from the tax deduction $ 34,113 Ramon will receive a better tax result by delaying the charitable contribution for one year ($6,684 = $34,113 − $27,429). This occurs for several reasons, including the fact that his contribution will be limited in the current year (due to the 60% of AGI limitation) and because, by delaying the contribution, the full amount of the deduction will generate tax savings based on a higher marginal income tax rate. In addition, by retaining the $113,000 until he makes the contribution, Ramon will benefit from the use of that cash until the contribution is made. However, the American Heart Association could be disadvantaged by having to wait for the gift. 35. (LO 6) a. Based on these facts, Roberta can deduct $660 as a charitable contribution for 2024. The deduction is based on the difference between the purchase price of the four tickets (4 × $200) and their fair market value (4 × $35). Giving the tickets to the minister is of no tax consequence because the minister is not a qualified charity. In addition, the $4,000 pledge to the church’s building fund is not deductible in 2024 because the amount is not actually paid until 2025.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

b. The pledge to the building fund of the church yields no deduction for 2024. It makes no difference whether Roberta uses the cash or the accrual method of accounting for tax purposes. Except for limited exceptions involving accrual basis corporations and fiduciary entities, charitable donations are deductible only in the year in which they are paid. Had the check that satisfied the pledge been mailed on December 31, 2024, Roberta could have claimed a deduction for 2024. As the situation is described, however, the $4,000 deduction relates to 2025. 36. (LO 6, 8)

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040

December 5, 2024 Ms. Eleanor Young 2622 Bayshore Drive Berkeley, CA 94709 Dear Ms. Young: I have evaluated the proposed alternatives for your current year-end contribution to the United Way. I recommend that you sell the Gold Corporation stock and donate the proceeds to the United Way. The four alternatives are discussed below. A donation of cash, the unimproved land, or the Gold stock will each result in a $23,000 charitable contribution deduction. Donation of the Blue Corporation stock will result in only a $3,000 charitable contribution deduction. A direct contribution of the Gold Corporation stock will be a poor decision from a tax perspective in that the decline in value of $5,000 ($23,000 − $28,000) is not deductible and the amount of the charitable contribution would be $23,000. However, you will benefit in two ways if you sell the Gold stock and give the $23,000 in proceeds to the United Way. First, donation of the proceeds will result in a $23,000 charitable contribution deduction. In addition, sale of the stock will result in a $5,000 long-term capital loss. If you have capital gains of $2,000 or more this year, you can use the entire loss in computing your current taxable income. If you have no capital gains this year, you can deduct $3,000 of the capital loss this year and carry over the remaining $2,000 loss to future years. You should make the donation in time for ownership to change hands before the end of the year. Therefore, I recommend that you notify your broker immediately so that there will be no problem in completing the donation on a timely basis. Please let me know if you have any questions or would like to discuss my recommendation and the related analysis. Thank you for consulting our firm on this matter. We look forward to serving you in the future. Sincerely, Nora Oldham, CPA Partner

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

37. (LO 2, 3, 4, 5, 7, 8) SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 January 23, 2025 Mr. and Mrs. Bart Forrest 2003 Highland Drive Durham, NC 27707 Dear Mr. and Mrs. Forrest: I have reviewed the tax information you provided and have determined that your Federal income taxes will be minimized by filing a joint return for 2024. A detailed computation that supports my conclusion is enclosed. Please let me know if you have any question or would like to discuss my recommendation in further detail. Thank you for consulting our firm on this matter. We look forward to serving you in the future. Sincerely, Richard Rodriguez, CPA Partner

Bart and Elizabeth Forrest Comparison of Joint and Separate Tax Liabilities Tax Year 2024

Separate and joint tax liabilities for 2024 are computed below. These computations are based on all information provided by Bart and Elizabeth Forrest. Bart $38,000

Elizabeth

Salary (Bart) Salary (Elizabeth) Interest income* Gross income Deductions for AGI AGI Medical expenses after 7.5%-of-AGI floor** State income tax*** Real estate tax*** Mortgage interest Total itemized deductions (MFS) or standard deduction (MFJ)**** Total deductions from AGI Taxable income

1,500 $39,500 (2,400) $37,100 $ 7,644 900 3,400 3,10 0

$110,000 2,300 $112,300 (14,000) $ 98,300 $ –0– 2,10 0 3,400 3,10 0

Joint $ 38,000 110,000 3,800 $151,800 (16,400) $135,400 $ 3,630 4,200 6,800 6,200

$1 5 ,044 ($1 5,044) $22,056

$ 8,600 ($ 8,600) $ 89,700

$ 29,200 ($ 29,200) $106,200

Tax

$ 2,4 1 5

$ 14,787

$ 13,470

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

Savings from filing jointly: Tax filing separately ($2,415 + $14,787) Tax filing jointly Savings from filing jointly

$ 17,202 (13,470) $ 3,732

*Interest income: Bart’s interest Elizabeth’s interest Their joint interest

Bart $ 400 1,10 0 $1,500

Elizabeth $1,200 1,100 $2,300

**Calculation of medical expense deduction: Medical expenses Less: 7.5% of AGI Medical expense deduction

Bart $10,427 (2,783) $ 7,644

Elizabeth $ 3,358 (7,373) $ 0

Joint $ 13,785 (10,155) $ 3,630

***State and local taxes are capped at $10,000 (married filing jointly) or $5,000 (married filing separately). Bart’s state and local taxes are below the $5,000 cap; Elizabeth’s state and local taxes exceed the $5,000 cap and so are limited to $5,000. ****If Bart and Elizabeth file separately, Bart is able to claim his medical expenses. When they file jointly, Elizabeth’s income causes an increase in AGI resulting in a much smaller medical expense deduction. This, along with the $10,000 cap on state and local taxes, means that they will claim the standard deduction ($29,200) because it exceeds the available itemized deductions ($19,830; $3,630 medical expense deduction + $10,000 maximum state and local tax deduction + $6,200 mortgage interest deduction). In this fact pattern, filing jointly presents a tax savings of $3,732 for Bart and Elizabeth. Ideally, the couple or their tax adviser would use tax preparation software to perform the calculations and help them determine the better filing status. 38. (LO 2, 3, 4, 5, 6, 7) Evan must reduce his medical expenses by 7.5% of AGI to determine the medical expense deduction. In addition, his state taxes are subject to the overall limit of $10,000. The medical expense deduction equals $10,203 [$31,000 (medical expenses) − (7.5% × $277,300)]. Medical expenses (net of 7.5%-of-AGI floor) Interest on home mortgage State taxes ($9,500 income and $3,600 real estate; limited to $10,000) Charitable contributions Total itemized deductions

$10,203 8,700 10,000 2,500 $31,403

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

39. (LO 2, 3, 4, 5, 6, 7) Linda’s itemized deductions are computed as follows: Medical expenses [$33,000 − (7.5% × $280,000)] State and local taxes ($4,800 income and $6,000 property; limited to $10,000) Home mortgage interest Charitable contributions Total itemized deductions

$12,000 10,000 5,000 7,000 $34,000

The automobile loan interest and the credit card interest are not deductible. The casualty loss is not deductible because it is a personal loss and did not occur in a Federally declared disaster area. The unreimbursed employee business expenses are miscellaneous itemized deductions (and are not deductible from 2018 through 2025). 40. (LO 2, 3, 4, 5, 6, 7) Stuart and Pamela’s itemized deductions are computed below: Casualty loss [$48,600 − (10% × $350,000)] Home mortgage interest State taxes ($18,000 income and $16,300 property; limited to $10,000) Charitable contributions Total itemized deductions

$13,600 19,000 10,000 28,700 $71,300

Interest paid on credit card debt is nondeductible. The tax return preparation fees are miscellaneous itemized deductions (and not deductible from 2018 through 2025).

TAX RETURN PROBLEMS 41. Part 1—Tax Computation Bruce’s salary Alice’s salary Interest income Adjusted gross income Less: Itemized deductions (Note 1) Taxable income

$ 62,100 58,000 2,750 $122,850 (36,486) $ 86,364

Tax from 2023 Married Filing Jointly Tax Table* Less: Prepayments and credits Income tax withheld ($5,300 + $4,500) Dependent tax credit (Note 2; 2 × $500) Net tax payable (or refund due) for 2023

9,925

(9,800) (1,000) ($ 875)

*The taxpayers are not subject to the AMT. For a discussion of the AMT, see Chapter 12. Completed tax forms for this problem are available on the Cengage Instructor Center.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

Notes (1) Itemized deductions are summarized below: Medical expenses: Medical insurance premiums Doctor bill for Sam paid in 2023 for services in 2022 Operation for Sam Prescription medicines for Sam Hospital expenses for Sam Total medical expenses Less: Reimbursement received in 2023 Less: 7.5% of $122,850 AGI Medical expenses deductible in 2023 Taxes: State income taxes ($3,100 + $2,950 + $900) Property taxes on residence

$ 4,500 7,600 8,500 900 3,500 $25,000 (3,600) (9,214) $ 6,950 5,000 $1 1 ,950

Overall limit on state and local taxes Qualified interest on home mortgage Charitable contributions (see Note 3): Church contribution $ 5,000 Tickets to charity dinner dance (Only the excess of the ticket price of $300 over the cost of comparable entertainment of $50 is deductible) 250 Used clothing donated (limited to fair market value) 350 Total itemized deductions

$12,186

10,000 8,700

5,600 $36,486

The expenses for Alice’s uniforms and laundry ($850 + $566) and Bruce’s professional journals and dues ($400 + $741) are employee business expenses (and miscellaneous itemized deductions). The deduction for miscellaneous itemized deductions is suspended from 2018 through 2025. Alice and Bruce would elect to itemize their deductions because total itemized deductions exceed the standard deduction of $27,700 for 2023 for married persons filing a joint return. (2) In addition to the Byrds’ son, John, Bruce’s father, Sam, qualifies as a dependent. Cynthia cannot be claimed as a dependent because she is not under age 24 (so she is not a qualifying child) and has too much income to be a qualifying relative. John does not qualify for the child tax credit since he is not under age 17 in 2023. But both John and Sam qualify for the dependent tax credit of $500. (3) Neither the $400 given to a needy family via a crowdfunding site nor the $65 given to homeless individuals qualifies for a charitable contribution because the amounts were not given to qualified organizations.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

Part 2—Tax Planning Bruce’s salary Interest income ($32,000 + $2,750) Adjusted gross income Less: Itemized deductions (Note 1) Taxable income

$ 88,000 34,750 $122,750 (33,863) $ 88,887

Tax liability from 2024 Married Filing Jointly Tax Rate Schedule

$ 10,202

Note (1) Itemized deductions are summarized below: Medical expenses: Medical insurance premiums Estimated costs for Alice ($15,400 − $6,400 reimbursement) Less: 7.5% of $122,750 AGI Taxes: State income taxes ($3,100 + $4,000) Property taxes on residence Overall limit on state and local taxes Qualified interest on home mortgage Charitable contributions Total itemized deductions

$ 9,769 9,000 (9,206) $ 7, 10 0 5, 100 $12,200

42. Paul’s salary Donna’s salary Dividends State income tax refund Long-term capital gain (Note 1) Adjusted gross income Less: Itemized deductions (Note 2) Taxable income Tax (Note 5) Less: Tax withheld ($5,770 + $5,630) Less: Child and dependent tax credits (Note 3) Net tax payable (or refund due) for 2024

$ 9,563

10,000 8,700 5,600 $ 33,863 $ 68,000 56,000 750 1,520 7,500 $133,770 (29,791) $103,979 $ 12,404 (11,400) (3,000) ($ 1,996)

Notes (1) Sale price of 300 shares Acme Corp. stock (300 × $50) Cost of stock (300 × $25) Recognized gain on sale (LTCG)

$ 15,000 (7,500) $ 7,500

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

(2) Itemized deductions: Medical expenses: Doctor and hospital bills ($12,700 − $2,000) Prescription drugs and medicine Insurance premiums Total medical Less: 7.5% of $133,770 AGI Deductible medical Taxes (limited to $10,000): State income taxes paid ($1,400 + $1,100) Real estate taxes Home mortgage interest Contributions: Church Books Total itemized deductions

$ 10,700 640 5,904 $ 17,244 (10,033)

$ 7,2 1 1

$ 2,500* 6,850 $ 4,600 740

9,350 7,890 5,340 $29,791

*The Deckers use the state income taxes paid because they exceed the sales taxes paid (per the sales tax table). (3) Because Donna is the custodial parent, Larry and Jane are the Deckers’ dependents. Because they provide over 50% of the support of Hannah, she also is a dependent. In 2024, Larry qualifies for the $2,000 child tax credit; his parent’s modified AGI is below $400,000, so the credit is not subject to phaseout. Jane does not qualify for the child tax credit (she is not under age 17 in 2024), but she does qualify for a dependent tax credit. Hannah also qualifies for a dependent tax credit. The total dependent tax credit is $1,000 ($500 × 2). (4) Consumer interest is not deductible. Therefore, neither the interest on the auto loan of $1,660 nor the credit card interest of $620 is deductible. (5) Tax on

$ 8,250* 95,729 $103,979

15%

= =

$ 1,238 11,166** $12,404

*$750 dividend + $7,500 LTCG = $8,250. **Determined using the 2024 Married Filing Jointly Tax Rate Schedule.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

RESEARCH PROBLEMS 1.

a. Code § 213 contains no ceiling limit on the amount of medical expenses. b. A capital expenditure will qualify as a medical expense if its primary purpose is the medical care of the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependent. However, the capital expenditure qualifies as a medical expense only to the extent the expenditure exceeds the increase in value of the related property (if the expenditure is directly related to medical care). Reg. § 1.213–1(e)(1)(iii). c. The facts in the research problem are similar to those in Collins H. Ferris, 36 TCM 765, T.C. Memo. 1977–186, where the IRS argued that the medical expense deduction should be limited to the cost necessary to produce a functionally adequate facility. The Tax Court held that the deduction did not have to be based on the cost of the least expensive pool that could have been built. The Tax Court said that there was no case law limiting a medical expense to the cheapest form of treatment. However, this Tax Court decision was reversed by the Seventh Circuit Court of Appeals, which held for the IRS [78–2 USTC ¶9646, 42 AFTR 2d 78–5674, 582 F.2d 1112 (CA–7)]. The Seventh Circuit held that the deductible amount should have been the minimum cost of a functionally adequate pool and housing structure. The court reasoned that the disallowed expenditures were personal expenditures incurred to ensure architectural and aesthetic compatibility with the related property—and not expenses for medical care—and, therefore, not deductible.

2. Tax deductions are provided to taxpayers by Congress as a matter of “legislative grace.” That is, an expenditure is deductible only if Congress enacts a provision allowing the expenditure to be deducted against income. Further, the burden of substantiating the amount of the deduction rests with the taxpayer and such substantiation involves providing evidence and records (e.g., canceled checks, bank statements, receipts from third parties) as required by the IRS in support of the amounts claimed. Self-serving or unverified testimony is not considered an adequate means of support. In the Bloughs’ situation, they have claimed deductions for expenditures that, at least theoretically, are deductible, but only if they can provide the required support. However, the Bloughs state that the amount of their deductions is based on averages calculated by the IRS and without regard to their actual experience. In Cheryl L. de Werff (T.C. Summary Opinion, 2011–29), the taxpayer claimed itemized deductions for amounts well in excess of what she could support. The Tax Court supported the IRS’s assertion that the taxpayer had not properly documented the deductions claimed. Consequently, the taxpayer was only allowed deductions for qualifying amounts for which adequate substantiation was provided. In addition, the taxpayer was subject to an accuracy-related penalty for the underpayment of taxes that resulted. The Bloughs should be encouraged to cooperate fully with the IRS’s request and to gather whatever records and support from their files that will support what has been claimed. If the amount of itemized deductions they can support is less than the standard deduction amount, they should claim the standard deduction amount for the year under review. Finally, they should also be prepared for the IRS to assess an accuracy-related penalty for their understated tax payment. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

SWFT, LLP 5191 Natorp Boulevard Mason, OH 45040 March 22, 2025 Ms. Marcia Meyer 1311 Santos Court San Bruno, CA 94066 Dear Ms. Meyer: You asked me to advise you concerning the amount of the deduction you may take for your contribution of stock to a charitable organization. You deducted $95,000 (the fair market value of the stock) on your tax return, and the IRS has reduced your deduction to $10,000 (the basis of the stock). For a contribution of property other than publicly traded securities, the Regulations require a taxpayer to obtain a qualified appraisal and attach a summary of the appraisal to the return on which the contribution is deducted. The Tax Court upheld this requirement in a recent case very similar to yours. Unfortunately, you are not able to correct the problem by filing an amended return with a qualified appraisal. Both the Regulations and the decision by the Tax Court support the IRS position in this matter. Therefore, you will be obligated to pay the required additional taxes and interest resulting from the disallowance of $85,000 of the charitable deduction you claimed. Thank you for consulting our firm on this problem. In the future, I urge you to seek professional tax advice before completing significant transactions that could have major tax implications. Please contact me if you wish to discuss this or any other tax matter. Sincerely, Joann Hanson, CPA References: Reg. § 1.170A−13(c)(2). John Hewitt, 109 T.C. 258 (1997), aff’d, 98−2 USTC ¶50,880, 82 AFTR2d 98−7164, 166 F.3d 332 (CA−4).

4. Temp.Reg. §§ 1.163–8T(c)(4) and (5) provides special 15-day rules for the interest tracing rules. Under this rule, for example, a taxpayer who receives debt proceeds deposited into a bank account can say that the debt proceeds were used for any expenditure made from that account within 15 days of the proceeds being deposited into the account. For example, assume that Joe borrows $25,000 from his bank on March 1 and the bank deposits the funds into Joe’s account. Joe uses the funds immediately to pay his personal credit card bills. As a result, the interest appears to be nondeductible personal interest expense. But assume that on March 5, Joe wrote a check on this account to pay $30,000 of his sole proprietorship (Schedule C) expenses. Under the 15-day rule, Joe can say that the debt proceeds really were used to pay the business expenses, making the interest expense on this loan deductible business interest expense.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

Reg. § 1.163–15, which replaces Notice 89–35, modifies the 15-day rule to be a period of 30 days before and after the date loan proceeds are deposited into an account or received in cash. Also, the taxpayer may look at any account rather than only the account where the loan proceeds were deposited. As a result, the Hortons can say that the loan proceeds received on March 5, 2017, were used to purchase the Microsoft stock they acquired on February 20, 2017, to the extent of that purchase price. The interest on that much of their home equity loan will produce investment interest expense.

RESEARCH PROBLEMS 5 TO 7 These research problems require that students utilize online resources to research and answer the questions. As a result, solutions may vary among students and courses. You should determine the skill and experience levels of the students before assigning these problems, coaching where necessary. Encourage students to use reliable websites and blogs of the IRS and other government agencies, media outlets, businesses, tax professionals, academics, think tanks, and political outlets to research their answers. 7. Student responses will vary. In general, students will find that the current versions of the AI tools often provide incomplete or incorrect answers. Evolution of the AI tools may lead to more complete and accurate results over time. During the development process for the 2025 edition, ChatGPT provided incomplete answers to all but one of these questions. For Problem 31, ChatGPT identified the $750,000 limit on acquisition debt, but did not compute the amount of the limited deduction. For Problem 33, ChatGPT correctly determined the contribution deduction if the stock was held for one year or less (part a.) and if the stock was held for more than one year (part b.). For Research Problem 1, ChatGPT identified the requirements for a deduction being allowed (medical necessity, home value increase, cost allocation), but did not provide a computation. It also was not able to deal with the “minimum adequate facility” issue.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

CHECK FIGURES 15. 16.a. 16.b. 17.a. 17.b. 18. 19. 20.a. 20.b. 21. 22. 23. 24. 25. 26. 28.a. 28.b. 29. 30.a. 30.b.

$2,050. Tabitha $855; Ramona $4,345. Amount realized $260,855; basis $260,855. $2,830. $630. $0. $157,500. $18,100. $15,000. $16,296. $10,825. $14,900. $5,950. $7,000 for AGI; $0 from AGI. $38,370. $5,600 for AGI ($3,000 + $2,600). $3,000 from AGI; $2,600 for AGI. $297,780 basis. $9,100. $1,800 income in 2025.

30.c. 30.d. 31. 32. 33.a. 33.b. 33.c. 34.a. 34.b. 34.c. 34.d. 35.a. 35.b. 36. 37. 38. 39. 40. 41. 42.

Income in 2025. $0 income in 2025. $11,250. None. $10,000. $17,000. $7,500. $95,000. $54,000. $60,000. Defer the deduction until next year. $660. No. Sell Gold Corporation stock and contribute the sales proceeds. Tax savings filing a joint return $3,732. $31,403. $34,000. $71,300. Refund for 2023, $875. Refund for 2024, $1,996.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

SOLUTION TO ETHICS & EQUITY FEATURE An Indirect Route to a Contribution Deduction (p. 10-20). If the committee had no knowledge that Rebecca was Chloe’s sister and was not influenced by the relationship, Chloe probably is justified in deducting any amount the church awarded to Rebecca. However, if the committee did know of the relationship and was influenced by Chloe’s suggestion, she should not deduct the $15,000 awarded to Rebecca. In that case, the $35,000 ($50,000 − $15,000) balance of the contribution is deductible.

SOLUTIONS TO BECKER CPA REVIEW QUESTIONS 1.

Choice “c” is correct. Medical expenses include physical therapy (professional medical services) and insurance premiums providing reimbursement for medical care. Prescription drugs are considered medical care. Insurance against loss of income is not payment for medical care and therefore is not deductible. Qualified medical expenses must be reduced by insurance reimbursement ($2,000 + $500 − $1,500 = $1,000). Choice “a” is incorrect. Insurance against loss of income is not payment for medical care and therefore is not deductible. Choice “b” is incorrect. Medical expenses include physical therapy (professional medical services) and insurance premiums providing reimbursement for medical care. Choice “d” is incorrect. Medical expenses include physical therapy (professional medical services) and insurance premiums providing reimbursement for medical care.

2. Choice “b” is correct. $12,900 of itemized deductions for the current year, calculated as follows: State income taxes paid Mortgage interest on her personal residence Points paid on purchase of her personal residence Deductible contributions to her IRA Uninsured realized personal casualty loss in Federally declared disaster area Tax preparation fees for her prior year income tax return Total itemized deductions for the current year

$ 2,000 9,000 1,000 – 900 – $12,900

•

Note: The personal casualty loss is deductible because the loss was in a Federally declared disaster area. The loss is deductible to the extent that it exceeds a floor of $100 and 10% of AGI. $6,000 − $100 = $5,900. $5,900 − ($50,000 × 10%) = $900.

•

Note: IRA contributions are “for AGI” deductions, not itemized deductions.

•

Note: Points paid on the purchase of a primary residence are deductible in full in the year of the purchase, not amortized over the life of the loan.

Choice “a” is incorrect. This answer option does not include any amount for the casualty loss. The casualty loss is deductible because it is located in a Federally declared disaster area. © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

Choice “c” is incorrect. This answer option includes the $400 tax preparation fee, which is not deductible. Choice “d” is incorrect. This answer option includes the IRA contribution as part of itemized deductions, but IRA contributions are adjustments to arrive at gross income on Form 1040, not itemized deductions. 3. Choice “b” is correct. The maximum Sydney is able to deduct for charitable contributions to her church is 60% of AGI. However, the amount is also limited to the actual amount contributed in the current year plus carryovers. In this case, Sydney contributed $15,000 of this in year 2 and had a carryover of $17,000 in contributions from a year 1 contribution. Since the year 1 contribution has not been carried over for more than five years, the contribution is not lost in year 2. Therefore, although the calculation of the maximum contribution (60% of AGI) is $48,000, the allowable contribution is limited to the lower amount actually contributed, or $32,000 ($15,000 + $17,000). Choice “a” is incorrect. The maximum Sydney is able to deduct for charitable contributions to her church is 60% of AGI. However, a taxpayer cannot deduct more than what is actually contributed (including carryovers). Therefore, although the calculation of the maximum contribution (60% of AGI) is $48,000, the allowable contribution is limited to the lower amount actually contributed in the current year plus carryovers, or $32,000 ($15,000 + $17,000). Choice “c” is incorrect. This amount is 60% of the actual contributions made in the current year plus carryovers. Choice “d” is incorrect. This answer option includes only the year 2 contribution amount of $15,000. The $17,000 carryover is allowable to be considered in the deductible contribution calculation in year 2 provided it has not been carried over for more than five years. 4. Choice “b” is correct. Kurstie’s refund is includable in gross income only to the extent that the original deduction provided a tax benefit. If Kurstie’s itemized deductions last year exceeded the standard deduction by $200, then the state income taxes deducted created a tax benefit of $200. Therefore, $200 of the state income tax refund received in the current year is taxable. Choice “a” is incorrect. Kurstie’s refund is includable in gross income only to the extent that the original deduction provided a tax benefit. If Kurstie’s itemized deductions last year exceeded the standard deduction by $200, then the state income taxes deducted created a tax benefit of $200. Therefore, $200 of the state income tax refund received in the current year is taxable, not $800. Choice “c” is incorrect. Kurstie’s refund is includable in gross income only to the extent that the original deduction provided a tax benefit. If Kurstie claimed the standard deduction in the prior year, then she did not receive a tax benefit from deducting the state income tax. Therefore, the state tax refund received in the current year is not taxable. Choice “d” is incorrect. The most Kurstie would include in gross income in this case would be the $800 refund. She did not receive $3,000.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

5. Choice “d” is correct. This deduction is not allowed if the taxpayer is a dependent of another taxpayer. Choice “a” is incorrect. There is a limitation of $2,500 on the deduction. $1,000 is well below this limit, so it is all deductible. Choice “b” is incorrect. The deduction starts to be phased out for a single taxpayer when AGI exceeds $65,000. $55,000 is well below this amount. Choice “c” is incorrect. The deduction starts to be phased out for a married taxpayer when AGI exceeds $135,000. $120,000 is well below this amount. 6. Choice “c” is correct. State income tax paid is an allowable itemized deduction (deductible from AGI), but taxpayers who file using the standard deduction (usually because it is higher than allowable itemized deductions, although there are some exceptions) will not get the benefit from those itemized deductions that total less than the standard deduction. Choices “a,” “b,” and “d” are incorrect. All of these are deductible to arrive at AGI and are termed “adjustments.” Adjustments benefit taxpayers who itemize as well as those who file using the standard deduction. 7. Choice “d” is correct. Chandler’s casualty loss is allowed as an itemized deduction because it is located in a Federally declared disaster area. Calculation of the loss: Smaller of damages or decrease in FMV Less: Insurance recovery Taxpayer’s loss Less: $100 floor Eligible loss Less: 10% of AGI Deductible loss

$50,000 (30,000) $20,000 (100) $19,900 (9,000) $10,900

Choice “a” is incorrect. A casualty loss is allowed as an itemized deduction if located in a Federally declared disaster area. The deductible loss equals the smaller loss amount (adjusted basis of property before or decreased FMV) minus insurance recovery minus $100 floor minus 10% of AGI. See calculation. Choice “b” is incorrect. A casualty loss is allowed as an itemized deduction if located in a Federally declared disaster area. The deductible loss equals the smaller loss amount (adjusted basis of property before or decreased FMV) minus insurance recovery minus $100 floor minus 10% of AGI. See calculation. Choice “c” is incorrect. A casualty loss is allowed as an itemized deduction if located in a Federally declared disaster area. The deductible loss equals the smaller loss amount (adjusted basis of property before or decreased FMV) minus insurance recovery minus $100 floor minus 10% of AGI. See calculation. 8. Choice “c” is correct. Marcela’s charitable contributions deduction is limited to the $10,000 gross proceeds from the charitable organization’s sale of the car. The car is ordinary income property because it is a personal-use asset that has depreciated in value. The donor’s deduction for ordinary income property that has depreciated in value is generally limited to the fair market value (FMV) of the property at the time it was donated

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

since it is less than the donor’s adjusted basis in the property. However, for the donation of a qualified vehicle that is subsequently sold by the charitable organization, the donor’s deduction is further limited. Since the FMV at the date of the donation is more than $500, Marcela’s deduction is limited to the lesser of the $12,000 FMV at the date of the donation or the organization’s $10,000 gross proceeds from the sale of the car, which is the $10,000 amount. Choice “a” is incorrect. Marcela’s charitable contributions deduction for the donation of her personal-use car to a charitable organization is not her $18,000 adjusted basis in the car because the car had depreciated in value at the time of the donation. Choice “b” is incorrect. Marcela’s charitable contributions deduction for the donation of her personal-use car to a charitable organization is not the $12,000 FMV at the time of donation because the car is a qualified vehicle that was sold by the organization for less than its FMV when it was donated. Choice “d” is incorrect. The donation of the car to the charitable organization is a qualified charitable contribution and Marcela’s deduction is limited to the $10,000 gross proceeds from the organization’s sale of the car. 9. Choice “a” is correct. Barbara and Kent’s best option is to pay the $5,200 current property tax bill in December of this year, itemize deductions this year, and take the standard deduction next year. Their total deduction for both years is $62,700 ($32,000 this year + $30,700 next year). If the current year property tax bill is paid in December, Barbara and Kent will have paid a total of $10,000 in property taxes this year, which is the maximum amount that can be deducted each year. Their total itemized deductions are $32,000 ($10,000 taxes + $10,000 mortgage interest + $12,000 charitable contributions), which is $4,300 more than their MFJ standard deduction of $27,700. Next year they will be better off taking the standard deduction rather than itemizing deductions. They will have only $12,000 in charitable contributions and a minimal amount of property taxes and mortgage interest because they are selling their home. Their standard deduction will increase by $3,000 ($1,500 × 2) because both Barbara and Kent will be 65 years old next year, so their total standard deduction will be $30,700. Choice “b” is incorrect. Barbara and Kent should itemize deductions this year if they pay the $5,200 current property tax bill in December. However, they are better off taking the standard deduction next year because it is significantly larger than their total itemized deductions next year. Choice “c” is incorrect. If Barbara and Kent pay the $5,200 current property tax bill in January of next year, their total itemized deductions will be only $26,800 this year ($4,800 taxes + $10,000 mortgage interest + $12,000 charitable contributions), which is less than their MFJ standard deduction of $27,700. Their total itemized deductions for the next year would also be lower because they are selling their home and will be significantly less than their MFJ standard deduction with the increased amount for age 65 and older of $30,700.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Chapter 10: Deductions and Losses: Certain Itemized Deductions

Choice “d” is incorrect. Paying the $5,200 current property tax bill in January of next year and taking the standard deduction both years is not the most beneficial option for Federal income tax purposes because they will not receive the additional benefit of bunching itemized deductions in the first year. Total deductions for both years is $62,700 ($32,000 this year + $30,700 next year) if they pay the property tax bill this year, itemize deductions this year, and take the standard deduction next year. Total deductions for both years is only $58,400 ($27,700 this year + $30,700 next year) if they take the standard deduction both years.

Solution and Answer Guide: Young, Persellin, Nellen, Maloney, Cuccia, Lassar, Cripe, SWFT Comprehensive Volume 2025, 9780357988817; Appendix F: Practice Set Assignments—Comprehensive Tax Return Problems

Solution and Answer Guide

YOUNG, PERSELLIN, NELLEN, MALONEY, CUCCIA, LASSAR, CRIPE, SWFT COMPREHENSIVE VOLUME 2025, 9780357988817; APPENDIX F: PRACTICE SET ASSIGNMENTS— COMPREHENSIVE TAX RETURN PROBLEMS

TABLE OF CONTENTS Problem 1 Solutions .............................................................................................................1 Problem 2 Solutions ........................................................................................................... 5

PROBLEM 1 SOLUTIONS 1.

Tyrese is self-employed. Therefore, he reports the $84,800 he received for services performed as an insurance claims adjuster and his deductible business expenses on Schedule C. Use Part I of Form 4562 to apply § 179 expensing for the waiting room furniture ($3,600) and copier ($300). The laptop computer ($2,100) and camera ($1,200) also qualify for § 179 expensing, which is carried from Part V of Form 4562 to Part I. Tyrese owes self-employment tax on his sole proprietorship profits, which is computed on Schedule SE. Tyrese qualifies for the qualified business income deduction with respect to the income generated in his sole proprietorship. The deduction is computed on Form 8995.

2. Depreciation on the Camry under the MACRS method (use Part V of Form 4562) is computed as follows: Cost First year percentage for five-year property First year depreciation deduction Business use Depreciation related to business use

$3 1,000 20% $ 6,200 92% $ 5,704

Tyrese’s deductible vehicle expenses other than depreciation total $6,715 [business tolls of $510 + (92% × $6,745) ($3,500 gas + $1,700 insurance + $820 interest + $325 auto club dues + $210 oil changes and lubrication + $190 license and registration)]. The combined deduction for actual vehicle expenses of $12,419 ($5,704 depreciation + $6,715 other) exceeds the $10,665 deductible expenses under the mileage method [$9,401 mileage (14,352 business miles × $0.655 mileage rate) + $510 of tolls + deductible interest on the car loan of $754 (92% × $820)]. Since the actual expense method yields a higher deduction than does the mileage method, Tyrese’s choice to use the actual expense method is logical. Regardless of the method for recovering vehicle costs, no deduction is allowed for the $350 in fines associated with Tyrese’s traffic violations.

3. Tyrese’s travel expenses for lodging are fully deductible. However, his travel meals as well as his in-town business dinners are subject to the limitation for business meals and entertainment. Thus, deductible business meals total $875 [($1,140 + $610) × 50%]. Tyrese’s contribution to his retirement plan and the medical insurance premiums are deductions for AGI that are reported on Part II of Form 1040 Schedule 1. Unfortunately, the premiums on disability insurance are not deductible. The receptionist is not technically Tyrese’s employee (she is paid by the landlord), but she serves in that capacity. Consequently, the $28 gift is a deductible business expense. Nominal charges for gift wrapping are disregarded when imposing the $25 limitation on business gifts. 4. Alexis’s contribution to her traditional IRA is a deduction for AGI and is reported on Part II of Form 1040 Schedule 1. The Jeffersons should claim a $200 credit for qualified retirement savings contributions, which is computed on Form 8880. This credit is reported as a nonrefundable credit on Part I of Form 1040 Schedule 3. Alexis’s employment-related expenses are miscellaneous itemized deductions subject to the 2%-of-AGI floor. Unfortunately, deductions for these expenses are disallowed for tax years 2018 through 2025. 5. Samuel Barkley is considered a qualifying dependent for the Jeffersons for 2023. It does not matter how long he lived during the year as long as he qualified as a dependent during the time he was alive. As such, all of Samuel’s medical expenses (i.e., $11,800) can be claimed by the Jeffersons on Schedule A as deductible medical expenses for 2023, as it is the year of payment that controls deductibility. Unfortunately, funeral expenses are not deductible for Federal income tax purposes. 6. Under § 1014, Alexis’s basis in the property she inherits from Samuel is the fair market value of the property at the time of Samuel’s death. For the house and land, this results in a step-up in basis to $220,000 and $50,000, respectively. For the furniture and appliances, however, a step-down to $14,000 occurs. In computing depreciation, the new basis under § 1014 controls. For depreciation purposes, the property is deemed placed in service as of March 1, when it was first advertised and available for rent. Using Form 4562, the depreciation totals $9,134 for 2020, comprised of $2,800 (20% × $14,000) for the furniture and $6,334 (2.879% × $220,000) for the building. Land is never depreciable. Repairs of $720 and newspaper advertising of $360 are deductible in computing net rental income on Schedule E. 7. Net rental income is reported on Schedule E. The 2023 rent receipts are summarized below. First and last month’s rent (2 × $2,400) May through November (7 × $2,400)

$ 4,800 16,800 $21,600

The rent for December is not taxed until 2024 because it was not received until then. The damage deposit is not taxed currently because it is only treated as income if it is forfeited (i.e., applied toward damages caused by the tenant). © 2025 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

All expenses except the paving assessment are deductible and should be reported on Schedule E. Note: The $720 of repairs made to ready the property for renting and the $320 of repairs made during the rental period are combined and reported on line 14 of Schedule E. The paving assessment should be added to the cost basis of the land. 8. Tyrese has a $10,000 loss from his investment in Pioneer Aviation because of the bankruptcy trustee’s announcement that the stock is worthless. Although it appears that the loss occurs within 12 months (i.e., early December 2022 to September 2023), worthless securities are deemed sold on the last day of the year of worthlessness. Thus, Tyrese has a $10,000 long-term capital loss which he reports on Form 8949 as well as on Schedule D of Form 1040. 9. When a taxpayer owns different blocks of the same stock, sells some of that stock, and does not specifically identify the block of stock that is sold, a FIFO approach is applied to determine the cost basis of the disposed stock. The broker was correct in quantifying the basis of the shares sold. Therefore, the Jeffersons sold the shares purchased in November 2022 for a short-term capital gain of $5,000 [$17,500 (selling price) – $12,500 (basis)]. The 700 shares they still own were acquired in April 2023. Since the basis was reported to the IRS on Form 1099–B, this disposition can be reported directly on Schedule D with no additional reporting on Form 8949. 10. Alexis’s basis in the coin collection is controlled by the gift rules of § 1015. Her basis for gain is her mother’s basis of $9,000. In this case, her basis for loss is also $9,000 (the $18,000 FMV on the date of the gift is not lower than the $9,000 basis). The measure of a theft loss cannot exceed the lesser of the basis ($9,000) or the FMV on the date of the theft ($24,000). Therefore, Alexis realizes a $1,000 long-term capital gain on the theft of the coin collection (a collectible) because the insurance recovery of $10,000 exceeds the $9,000 measure of the theft loss. This gain is reported on Form 4684 and also Schedule D. Since the taxpayers’ long-term capital losses exceed their short-term capital gains, the Jeffersons are permitted to deduct ($3,000) of the net loss against their other income. The remaining ($300) will be a long-term capital loss carryforward to their 2024 tax year. 11. Under the application of § 1014, Alexis’s basis in the lot on Wright Street is $19,000 which is the FMV on the date of Ella’s death. Upon the later sale of the property, Alexis received $19,700 of consideration since the buyer agreed to pay the back taxes in arrears on the property. Therefore, Alexis has a long-term capital gain of $700. Since Alexis did not pay the property taxes associated with this land, she cannot deduct them. This sale is reported on Form 8949 with Box E checked because the basis was not reported to the IRS on Form 1099–B. 12. True gifts are not common in a business setting. The presumption is that these “gifts” are compensation for services rendered (i.e., referrals) or to be rendered in the future. It does not matter that there was no obligation or prior agreement to make the payments. Tyrese reports $7,200 of other income on his Schedule C for the year. The $900 received on January 4 will be taxed in 2024, the year it was received. While the solution presents the majority view that such transfers are not true gifts, taxpayers have disputed this tax treatment in the courts.

13. The garage sale netted a realized loss of $16,300 ($9,200 proceeds – $25,500 cumulative bases). This realized loss is personal and therefore not tax deductible. The $9,200 proceeds are a partial return of capital and are therefore not taxable. 14. Under the tax benefit rule, the state tax refund is income reported on Form 1040 Schedule 1. Refunds of Federal income tax are never taxable income. The interest on Michigan bonds is tax exempt. Nevertheless, it must still be reported on Form 1040 page 1. The qualified dividends are subject to the same tax rate as long-term capital gains. The cash gifts from Tyrese’s parents are nontaxable. The gambling winnings and losses must be reported, but they are not netted. The winnings are reported on Form 1040 Schedule 1. The losses are reported on Schedule A as Other Itemized Deductions, but the deduction is limited to Tyrese’s gambling winnings of $1,000. 15. The medical expenses eligible for deduction total $14,346 [$1,300 medical expenses + $1,200 dental expenses + $11,800 of Samuel’s medical expenses + $46 for medical mileage (209 medical miles × $0.22 mileage rate)]. The deduction is the excess of such expenses over 7.5% of AGI. Even though the Jeffersons’ state and local taxes paid sum to $10,256, their deduction on Schedule A is limited to $10,000. Students can confirm that the Jeffersons’ donation to The Waters Edge Church qualifies for a tax deduction by using the Tax-Exempt Organization Search (TEOS) tool on the IRS website (www.irs.gov). The charitable deduction is based on the amount paid and not on the pledge year involved. Thus, the full $4,600 is deductible in 2023. Plus, the Jeffersons can deduct $45 (320 miles × $0.14) for the use of the Malibu for charitable purposes. 16. Samuel, Jalen, and Lamar qualify as Tyrese and Alexis’s dependents for the tax year. As such, the Jeffersons should claim a $2,000 child tax credit for Lamar since he is under the age of 17. They should also claim a $500 other qualifying dependent tax credit for both Samuel and Jalen. 17. Alexis’s wages are reported on Form 1040. Her Federal income tax withholding and the sum of the couple’s quarterly estimated taxes are reported on Form 1040. Alexis’s state income tax withheld is combined with the other state taxes paid by the Jeffersons and entered on Schedule A. 18. The Jeffersons should report that they have no dealings with digital assets on Form 1040 page 1 and foreign financial accounts or trusts on Form 1040 Schedule B.

19. A brief summary of the Jeffersons’ tax return for 2023 appears below. Gross income: Salary Schedule B Taxable state tax refund Schedule C Schedule D Schedule E Other (gambling) Total income Deductions for AGI: Deductible self-employment tax Deduction for contribution to retirement plan Deduction for health insurance IRA deduction AGI: Schedule A—itemized deductions (deductions from AGI) Qualified business income deduction Taxable income

$ 36,000 3,200 90 51,688 (3,000) 6,1 26 1,000 $ 95,10 4 (3,652) (8,000) (4,600) (6,000) $ 72,852 (29,283) (7,087) $ 36,482

Computing tax using the tax rate tables yields an income tax liability of $3,793. The child and other qualifying dependent tax credit of $3,000 and the retirement savings contribution credit of $200 reduce this to $593. To this is added the self-employment tax of $7,303 (see Schedule SE) for a total tax due of $7,896. Since the Jeffersons paid a total of $8,920, the resultant overpayment of $1,024 will be refunded to them.

PROBLEM 2 SOLUTIONS 1.

When a retirement annuity originates from a contributory qualified plan, part of each payment represents a return of the employee’s investment. Use the Simplified Method Worksheet in the Instructions to Form 1040 to determine the number of anticipated monthly payments (260 in this case) and compute the nontaxable exclusion of $11,538 ($250,000 investment in plan ÷ 260 anticipated payments × 12 months). The taxable portion of the annuity payment is $48,462 ($60,000 – $11,538).

2. Jose’s consulting income is reported on Schedule C. His expenses are deductible except for the limitation on business meals of $1,100 (50% × $2,200). Jose owes selfemployment tax on his sole proprietorship profits, computed on Schedule SE. Jose also qualifies for the qualified business income deduction. 3. Rosa is self-employed and should file her own Schedule C. As a cash-basis taxpayer, she recognizes income in the year payment is received. Consequently, she reports $48,000 of gross income for 2023, determined as follows: 11 portraits paid for when delivered (11 × $3,200) Prepayment for 2024 portrait 3 portraits painted and delivered in 2022 (3 × $3,200)

$35,200 3,200 9,600 $48,000

Rosa’s Schedule C should reflect business expenses of $3,010 for her painting supplies (plus others per item 18). Rosa will compute self-employment tax on her sole

proprietorship profits on Schedule SE. Rosa also qualifies for the qualified business income deduction. Because the couple’s taxable income is below $364,200, they can use a single Form 8995 to compute the QBI deduction for both businesses. 4. Since one-fourth of the Navas’ home is devoted to Rosa’s studio, costs associated with this space are deductible as a home-office deduction. Of the expenses listed, those for stain removal from studio flooring and repair of the studio skylight are direct and can be claimed in full. The remaining expenses are indirect, and only one-fourth can be claimed. Depreciation of $2,244 is computed using the rate of 2.564% for recovery years 2–39 for nonresidential realty [2.564% × (¼ × $350,000)]. Form 8829 should be filed to claim the home-office deduction. 5. The LaBeaux Place transaction resulted in a realized gain of $220,000 [$250,000 (value received) – $30,000 (basis of property given up)]. However, the transaction qualifies as a like-kind exchange under § 1031. Therefore, a gain of only $10,000 is recognized due to the receipt of cash boot. This gain is computed on Form 8824 and reported on Schedule D as a long-term capital gain. 6. Even though no actual condemnation proceeding took place, the disposition of Block 46 still qualifies as an involuntary conversion under § 1033. The threat was present, and the settlement merely avoided a court proceeding. Since the conditions of § 1033 are satisfied and Jose reinvested $175,000 of the $180,000 of proceeds, Jose need only recognize a $5,000 long-term capital gain because that is the amount of proceeds not reinvested in property “similar or related in service or use.” Since the unimproved land is investment property (a capital asset held in connection with a transaction entered into for profit) and held more than one year, it is a § 1231 asset. The condemnation is reported on Part I of Form 4797. 7. The RV purchase and sale was an unfortunate experience for Jose and Rosa. The result is a $10,000 loss that is not tax deductible because it is personal in nature. They will, however, be able to add the sales tax paid ($6,250) to the IRS table amount in computing the deduction for state and local sales taxes. 8. Jose’s basis in the Ragusa stock is controlled by the gift rules of § 1015. Therefore, his basis for gain is his father’s basis of $16,000 (or $40 per share). In this case, his basis for loss is also $16,000, since the $20,000 FMV on the date of the gift is not lower than the $16,000 basis. After the stock split, the total basis remains the same, but the pershare basis drops to $20 ($16,000 ÷ 800 shares). When Jose sells 400 shares for $20,000, his gain is $12,000 [$20,000 (selling price) – $8,000 (basis)]. The $12,000 longterm capital gain is reported on Form 8949 as a transaction reported on Form 1099–B for which basis was not reported to the IRS, given Jose’s acquisition via gift. 9. The sale of Cormorant Power stock yields a loss of $10,000 [$50,000 (basis) – $40,000 (selling price)]. The repurchase of the stock on February 19, 2024, does not disallow the loss because it is more than 30 days after the December 21, 2023, sale of stock at a loss. Thus, the December sale is not considered a wash sale. A $10,000 short-term capital loss is reported directly on Schedule D since the basis was reported to the IRS on Form 1099–B. 10. The IRS will scrutinize a personal loan between friends to determine whether a valid debt was intended. Based on the facts presented, the debt appears to be bona fide because there was a written note with a specified due date and a provision for interest

on the loan. While the problem doesn’t specifically state that Rosa attempted to collect on the loan, this can be inferred from her knowledge of Ava’s troubles with the law. Since Ava is “on the run,” Rosa can argue that this valid debt is uncollectible. This nonbusiness bad debt is treated as a short-term capital loss. 11. The long-term capital loss carryover of $7,000 is entered on Schedule D for application against current long-term capital gains. 12. Students can confirm that Jose’s donation to the Remember the Alamo Foundation qualifies for a tax deduction by using the Tax-Exempt Organization Search (TEOS) tool on the IRS website (www.irs.gov). Since the gun collection is long-term capital gain property in Jose’s hands, he is permitted to include the appreciation in value in computing the charitable donation deduction. Consequently, $16,000 (fair market value on date of the contribution to the museum) can be claimed as a contribution deduction on Schedule A. Form 8283 must be included with the return in support of this deduction. 13. The life insurance proceeds are reported nowhere on the tax return because they are not taxable receipts. 14. With respect to the settlement Rosa receives for being hit by the truck, $126,000 is nontaxable because it is payment of damages with respect to a physical injury. The remaining $8,000 is also not taxable since it compensates Rosa for loss of income that is a direct result of the physical injury she sustained. 15. The $1,000 refund of the insurance policy deductible is not a taxable receipt. The tax benefit rule does not apply because Jose did not deduct the $1,000 last year when he paid it. 16. Jose and Rosa’s two granddaughters meet the definition of a qualifying child, and Madeline meets the definition of a qualifying relative. Madeline does not fail the gross income test because the $4,900 she received is nontaxable child support. As such, the Navas should claim a $2,000 child tax credit for both Olivia and Emma because they are under the age of 17. They should also claim a $500 other qualifying dependent tax credit for Madeline. These credits are claimed on Form 8812. 17. Because of Jose and Rosa’s other sources of taxable income, $15,300 of Jose and Rosa’s combined Social Security benefits are taxable (85% × $18,000). The qualified dividends are subject to the same tax rate as long-term capital gains. The interest on the City of Beaumont bonds is nontaxable. Nevertheless, it must still be reported on Form 1040. 18. The cost of a divorce is a personal expenditure and is generally not tax deductible. The medical expenses eligible for deduction total $13,844 ($2,244 Medicare premiums + $3,600 health care premiums for dependents + $8,000 dental implants). The deduction is the excess of such expenses over 7.5% of AGI. The taxes and mortgage interest on the personal residence must be allocated between the portion that relates to the office in the home (25%) and the personal portion reported on Schedule A (75%).

Since the Navas don’t have receipts for all of their sales tax paid during the year, they should use the General Sales Tax Deduction worksheet included in the Schedule A instructions to compute their deduction. To find the correct amount of sales tax from the optional table, “income” is AGI plus nontaxable Social Security and retirement benefits and muni bond interest. While the Navas pay local sales taxes, they are not factored into the sales tax deduction. However, the sales tax paid on the RV is included in the computation in the worksheet. The Navas’ state and local tax deduction on Schedule A is limited to $10,000. Students can confirm that the donations to New Samaria Baptist Church qualify for a tax deduction by using the Tax-Exempt Organization Search (TEOS) tool on the IRS website (www.irs.gov). Charitable contributions made this year include the pledge paid to the Navas’ church as well as the donation of the $16,000 gun collection to a qualified charity. The subscription to professional journals, the dues to professional organizations, and the state license fee should be reported on Jose and Rosa’s respective Schedules C. This is also true of $450 (1/2 × $900) for the tax return preparation fee, with Jose reporting $200 and Rosa reporting $250 on their respective Schedules C. The remaining tax return prep fee is a personal expense that is a miscellaneous itemized deduction subject to the 2%-of-AGI floor. Unfortunately, deductions for these expenses are disallowed for tax years 2018 through 2025. 19. Jose’s Federal income tax withheld from his pension is reported on line 25b of Form 1040. The sum of the couple’s quarterly estimated tax payments and the overpayment from 2023 are reported on line 26 of Form 1040. 20. The Navas should report that they have no dealings with digital assets on Form 1040 page 1 and foreign financial accounts or trusts on Form 1040 Schedule B. 21. A brief summary of the Navas’ tax return for 2023 appears below. Gross income: Schedule B Schedules C—combined Schedule D Taxable pension Taxable Social Security benefits Total income Deductions for AGI: Deductible self-employment tax—combined AGI: Schedule A—itemized deductions (deductions from AGI) Qualified business income deduction Taxable income

$ 2,900 61,293 4,000 48,462 15,300 $131,955 (4,331) $127,624 (33,122) (11,392) $ 83,110

Computing tax using the tax rate tables yields an income tax liability of $8,863. The child and other qualifying dependent tax credit of $4,500 reduces this to $4,363. To this is added the self-employment tax of $8,660 ($3,419 + $5,241) (see Schedule SE) for a total amount due of $13,023. Since the Navas paid a total of $16,900, the resultant overpayment of $3,877 will be applied to their 2024 estimated tax.

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