Taxation homework help

In integrative problem 85 in Chapter 4, you were asked to calculate Carmin’s gross income for 2011. This is the second phase, which provides the additional information necessary for you to calculate her taxable income, income tax liability, and additional tax (or refund due). NOTE: The gross income items from problem 85 still apply. However, some additional items might affect the amount of gross income that Carmin must report. That is, several items included in the gross income from integrative problem 85 are either not reported as gross income or need to be combined with the additional information in this problem to determine the correct treatment. Therefore, you should make the appropriate adjustments to gross income in integrative problem 85, and begin your tax calculation under the heading of Gross Income from Problem 85, As Adjusted.

From this point on, any items of gross income from the information in this problem should be listed to determine gross income for tax purposes. You do not need to list all the individual gross income items from integrative problem 85 in your solution. However, you should explain the adjustments made to the phase 1 gross income figure as part of your discussion of the solution.

Carmin has the following amounts withheld from her paycheck for the payment of state income taxes, federal taxes, and Social Security taxes:

State income taxes ………. $ 4,768

Federal income taxes …….. 11,123

Social Security taxes ……… 6,120

Calculate Carmin’s taxable income, income tax liability, and tax (or refund) due on her 2011 tax return. Then do one or both of the following, according to your professor’s instructions:

a. Include a brief explanation of how you determined each deduction and any item you did not treat as a deduction. Your solution to the problem should contain a list of each deduction and its amount, with the explanations attached.

b. Write a letter to Carmin explaining how you determined each deduction and any items you did not treat as a deduction. You should include a list of each deduction and its amount.

SOLUTION

Gross Income:

Gross income from phase 1 $ 74,306

Additional ordinary income from S corporation 5,400

State tax refund 60

Carmin's business income 11,206

Total gross income $ 90,972

Deductions for adjusted gross income:

Alimony from phase 1 ($100 x 12) $ 1,200

Net rental loss 1,660

Self-employment tax deduction 792

Capital loss deduction 3,000 (6,652)

Adjusted gross income $ 84,320

Deductions from adjusted gross income:

Unreimbursed medical expenses $ 2,845

Less: AGI limit ($84,320 x 7.5%) (6,330) $ -0-

Taxes

State income tax $ 4,768

Estimated state taxes ($150 x 4) 600

2010 state tax paid in 2011 245

Property taxes on residence 1,584

Fire tax 136

Property taxes on personal auto 168 7,501

Interest

Home mortgage interest $ 5,200

Home equity loan interest 850

Refinancing points amortization 80 6,130

Charitable contributions

Paid in cash $ 2,465

Contribution of property 360 2,825

Casualty loss

Unreimbursed loss $ 5,700

Less: Statutory floor (100)

Less: Limit ($84,320 x 10%) (8,432) -0-

Miscellaneous deductions

Employee business expenses 1,055

Other miscellaneous deductions 520

Less: Limit ($84,320 x 2%) (1,686) -0-

Total itemized deductions (16,456)

Personal and dependency exemptions (2 x $3,700) (7,400)

Taxable income $ 60,464

Tax on ordinary income of $60,164 ($60,464 - $300)

{$6,330.00 + [25% x ($60,164 - $46,250)]} $ 9,809

Tax on dividend income from phase 1 ($300 x 15%) 45

Add: Carmin's self-employment tax 1,595

Total tax liability $ 11,437

Less: Child tax credit (500)

Less: Estimated tax payments ($400 x 4) (1,600)

Less: Withholdings (11,123)

Tax Refund $ (1,786)

Additional Gross Income Sources:

Carmin must include her state income tax refund of $60 in gross income.

Carmin's Business

In Phase 1 of the tax return Carmin reported income from Grubstake Mining and Development of $2,000. However, because some of the items reported by Grubstake receive special tax treatment she cannot report the net amount of $2,000 ($7,400 + $300- $5,200 - $500) as ordinary income. Therefore, she must include an additional $5,400 ($7,400 - $2,000 reported in Phase 1) as ordinary income. The tax treatment of the short-term capital gain, long-term capital loss and the charitable contribution are discussed below.

All of the facts indicate that Carmin's activities constitute a trade or business. Therefore, all ordinary and necessary business expenses are deductible For AGI. As a matter of practice, the allowable expenses are netted against the gross income from the business and reported as a net figure.

Commissions $ 24,230

Deductible expenses:

Advertising $ 4,300

Telephone 550

Real estate license 160

Automobile expenses 4,390

Interest on car 140

Property tax on car 112

Tax preparation 550

Home office expenses 2,822 $(13,024)

Business income $ 11,206

Carmin’s car is used 40% (8,000 ÷ 20,000) of the time in her business. Because she does not keep track of her actual expenses she must use the standard mileage rate of 51 cents per mile. Carmin can deduct her parking and tolls. Because she is self-employed, she can also deduct 40% of the interest on her car loan and personal property taxes on the car.

Mileage (8,000 miles x 51 cents) $ 4,080

Tolls 85

Parking 225

Allowable automobile costs $ 4,390

Property tax ($280 x 40%) 112

Interest ($350 x 40%) 140

Because Carmin uses a portion of her home (i.e., the basement) for her business, a portion of the expenses she incurs in maintaining the home are deductible as a business expense. The most common method for allocating the expenses is square footage. The total square footage of Carmin’s house is 3,000 (2,400 square foot living area + 600 square foot basement). Therefore, 20% (600 square feet ÷ 3,000 square feet) of the expenses in maintaining the home are deductible. In addition, Carmin can depreciate 20% of her home. Therefore, Carmin’s depreciation deduction is $415 ($2,077 x 20%).

The following summarizes Carmin’s allowable home office deduction.

Interest ($6,500 x 20%) $1,300

Real estate taxes ($1,980 x 20%) 396

Fire tax ($170 x 20%) 34

Water ($205 x 20%) 41

Electric ($980 x 20%) 196

Gas ($630 x 20%) 126

Insurance ($1,470 x 20%) 294

Interest refinancing ($100 x 20%) 20

Depreciation (see above) 415*

Total home office deduction $2,822

* The depreciation of $2,077 provided in the book is before the allocation discussed above

Deductions For Adjusted Gross Income

The $300 short-term capital gain and the $1,220 short-term capital loss from Phase I must be netted together giving her a $920 short-term capital loss. In addition she has a $5,200 long-term capital loss reported to her by Grubstake Mining and Development and a long-term capital gain of $110 for a net long-term capital loss of $5,090 ($110 gain - $5,200 loss). Because the loss is greater than $3,000, she can deduct only $3,000 and the short-term capital loss of $920 must be used first. Her long-term capital loss is reduced by $2,080 ($3,000 - $920) and the remaining loss of $3,010 ($5,090 - $2,080) is carried forward to 2012.

Carmin is self-employed and must pay the self-employment tax on her net earnings from self-employment. She is allowed to deduct 1/2 of the self-employment tax paid as a deduction for adjusted gross income. This results in only 92.35% of the self-employment income subject to the tax. Because Carmin’s $80,000 salary from her job at ASCI leaves her $26,800 ($106,800 - $80,000) under the Social Security maximum of $106,800, she has to pay Social Security tax on all of her self-employment income. Her self-employment tax is $1,583 [($11,206 x 92.35%) x 15.3%] and her deduction is $792 ($1,583 x 50%). NOTE: The self-employment tax does not reflect the one-time 2% decrease in FICA enacted for 2011.

Alimony paid is deductible for adjusted gross income. Alimony payments that are reduced based on a contingency related to a child are reduced to the amount that will be paid after the contingency. Carmin's alimony payment will be reduced to $100 per month when Julius reaches age 18. Therefore, Carmin can only deduct $1,200 ($100 x 12) of the payments made to Ray as alimony.

Deductions From Adjusted Gross Income

Individuals are allowed to deduct the greater of their allowable itemized deductions or their standard deduction. Carmin's allowable itemized deductions exceed the standard deduction for filing as head of household.

Medical Expenses: Unreimbursed medical expenses in excess of 7 1/2% of AGI are allowed as an itemized deduction. Carmin's allowable medical costs total $2,845. The allowable costs include those for doctors ($390), dentists ($310), chiropractor ($265), optometrist ($125), emergency room charges ($440), prescription drugs ($215) and the unreimbursed expenses ($1,100 = $1,900 - $800) from ASCI’s flexible benefits plan (see Phase I information). Over-the-counter drugs are not deductible. The health club dues paid on her behalf by ASCI are not deductible medical expenses because they are not a treatment for a specific medical condition. The $2,845 of allowable medical expenses must be reduced the 7 1/2% of AGI limitation leaving Carmin with no deduction for medical expenses.

Taxes: State and local income taxes paid during 2011 are allowed as a deduction. This includes the amounts withheld from her salary ($4,768), $600 ($150 x 4) in quarterly estimated tax payments and the additional 2010 state tax that is paid in 2011 ($245). Real and personal property taxes are also deductible. Because Carmin uses part of her home for her business she must allocate a portion (20% - see calculation above) of the real estate tax and fire tax to her business. Therefore, she can only deduct $1,584 ($1,980 x 80% (100% - 20%)] of her real estate taxes and $136 [($170 x 80% (100% - 20%)] of her fire tax as an itemized deduction.

Carmin can deduct the $280 in property taxes paid to the town because the taxes are based on the value of the car. However, 40% (see calculation above) of the property tax is business related. Therefore, she only can deduct $168 [($280 x 60% (100% - 40%)] as an itemized deduction.

Interest: Only qualified home mortgage interest is deductible. Interest paid on up to $100,000 of home equity loan debt is qualified mortgage interest. As with the real estate and fire taxes, because Carmin uses part of her home for her business she must allocate 20% (see calculation above) of the mortgage interest to her business. Therefore, she can only deduct $5,200 [($6,500 x 80% (100% - 20%)] of the home mortgage interest as an itemized deduction. Carmin should not allocate a portion of the home equity interest to her business because the loan proceeds were used to renovate the kitchen and bathroom and to pay off credit card debt. She should deduct the full amount, $850, of the home equity interest as an itemized deduction.

Points paid to obtain an initial mortgage are deductible in the year paid. However, points paid to refinance an existing mortgage must be amortized over the term of the new loan. The $1,800 of points paid on the refinancing must be amortized over the 15 year term of the new mortgage ($1,800 ÷ 15 = $120 per year)]. Because the refinancing was done on March 1, only ten months $100 [($120 x (10 ÷ 12) of the current year’s amortization is deductible. However, since $20 ($100 x 20%) was allocated to the home office, only $80 ($100 - $20) is deductible.

Charitable Contributions: Contributions to qualified charitable organizations are deductible. Larkin College ($850), the First Methodist Church ($790), the United Way ($125), and the homeless shelter ($200) are qualified charitable organizations. The $500 allocated from Grubstake Mining and Development is considered a cash contribution. The $360 property contribution to the Salvation Army is deductible.

Casualty Loss: The theft of cash and the jewelry is an allowable personal casualty loss. The loss is measured as the lesser of the decline in value, or the basis of the item. The measured loss for the jewelry is $6,000 and $300 for the cash. Carmin’s basis in the jewelry is the fair market value when her grandmother died. The total measured loss is $6,300 ($6,000 + $300) and is reduced by the $600 ($500 + $500) of insurance proceeds for an unreimbursed loss of $5,200. The $100 statutory floor reduces the loss to $5,200. The $5,200 loss is subject to an annual limitation of 10% of adjusted gross income. Subtracting the 10% limitation of $8,432 ($84,320 x 10%) results in no casualty loss deduction on the theft.

Miscellaneous Itemized Deductions: Because Carmin is reimbursed for only 90% ($10,800 ÷ $12,000) of her business expenses, she can deduct the remaining 10% of the expenses as unreimbursed business expenses. However, the meal and entertainment expenses allocated to Carmin must be reduced by 50%.

Airfare ($4,700 x 10%) $ 470

Hotel ($3,400 x 10%) 340

Car rental ($600 x 10%) 60

Incidentals ($400 x 10%) 40

Meals ($2,000 x 10% x 50%) 100

Entertainment ($900 x 10% x 50%) 45

Total unreimbursed employee expenses $ 1,055

Carmin also can deduct the $295 for business publications and the $225 ($775 - $500 business related) in tax preparation fees. Her total allowable miscellaneous deductions of $1,575 ($1,055 + 295 + $225) are reduced by $1,688 (2% x $84,320), resulting in no miscellaneous itemized deduction.

Exemption Deductions

Carmin is allowed one personal and one dependency deduction (Anika). Carmin is the custodial parent of Anika but not her son, Julius. This gives her a total deduction of $7,400 ($3,700 x 2).

Calculation of Tax Due (Refund)

Carmen’s taxable income for the year is $60,464. However, the $300 of dividend income is taxed at 15%. The remaining $60,164 ($60,464 - $300) of taxable income is calculated using the 2011 head of household tax rate schedule. Her self-employment tax of $1,595 is added to the $9,854 ($9,809 + $45) income tax liability resulting in a 2011 tax liability of $11,437. The tax liability is reduced by her $500 child tax credit. The $1,000 credit must be reduced by $50 for each $1,000 dollars or fraction thereof of adjusted gross income in excess of $75,000. Therefore, she must reduce the child credit by $500 (see calculation below). Carmen's tax liability after the child tax credit is 10,937 ($11,437 - $500).

The tax liability of $10,937 is reduced by the amount withheld on her salary of $11,123 and $1,600 ($400 x 4) of federal quarterly estimated tax payments resulting in a tax refund of $1,786 ($10,937 - $11,123 + $1,600).

Child Credit Phase-out:

($84,320 - $75,000)  $1,000 = 9.32 (rounded to 10)

$50 x 10 = $500 reduction in credit

$1,000 - $500 = $500 allowable child tax credit

Items that are not deductible:

The loss on the $10,000 loan to Ray is a nonbusiness bad debt. Nonbusiness bad debts are deductible as short-term capital losses in the year the debt becomes worthless. Therefore, Carmin does not receive benefit for the $10,000 capital loss until 2012.

The contributions to the sorority and the local chamber of commerce are not deductible charitable contributions.

Carmin’s $70 car registration cannot be deducted.

Federal income taxes and Social Security taxes cannot be deducted.

The interest on the credit card debt and the interest on the car loan attributable to her personal use of the car are both considered personal interest and not deductible.