FULLY UPDATED FOR THE TAX CUTS AND JOBS ACT 2019 EDITION TAXATION of INDIVIDUALS AND BUSINESS ENTITIES McGraw-Hill’s SPILKER • AYERS • BARRICK • OUTSLAY • ROBINSON • WEAVER • WORSHAM McGraw-Hill’s Taxation of Individuals and Business Entities Brian C Spilker Brigham Young University Editor Benjamin C Ayers John A Barrick The University of Georgia Brigham Young University Edmund Outslay John R Robinson Michigan State University Texas A&M University Connie D Weaver Ron G Worsham Texas A&M University Brigham Young University McGRAW-HILL’S TAXATION OF INDIVIDUALS AND BUSINESS ENTITIES, 2019 EDITION, TENTH EDITION Published by McGraw-Hill Education, Penn Plaza, New York, NY 10121 Copyright © 2019 by McGraw-Hill Education All rights reserved Printed in the United States of America Previous editions © 2018, 2017, and 2016 No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning Some ancillaries, including electronic and print components, may not be available to customers outside the United States This book is printed on acid-free paper LWI 21 20 19 18 ISBN 978-1-259-91839-1 MHID 1-259-91839-4 ISSN 1946-7745 Executive Portfolio Manager: Kathleen Klehr Product Developers: Danielle Andries, Erin Quinones Marketing Manager: Zach Rudin Content Project Managers: Lori Koetters, Jill Eccher, Brian Nacik Buyer: Susan K Culbertson Design: Matt Backhaus Content Licensing Specialist: Lorraine Buczek Cover Image: © Spotmatik/Alamy Compositor: Aptara®, Inc Printer: LSC Communications All credits appearing on page are considered to be an extension of the copyright page The Internet addresses listed in the text were accurate at the time of publication The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites mheducation.com/highered Dedications We dedicate this book to: My family, whose love and support helped make this book possible, and to Professor Dave Stewart for his great example and friendship over the last three decades Brian Spilker My wife, Marilyn, daughters Margaret Lindley and Georgia, son Benjamin, and parents Bill and Linda Ben Ayers My wife, Jill, and my children Annika, Corinne, Lina, Mitch, and Connor John Barrick My family, Jane, Mark, Sarah, Chloe, Lily, Jeff, and Nicole, and to Professor James E Wheeler, my mentor and friend Ed Outslay JES, Tommy, and Laura John Robinson My family: Dan, Travis, Alix, and Alan Connie Weaver My wife, Anne, sons Matthew and Daniel, and daughters Whitney and Hayley Ron Worsham About the Authors Brian Spilker (PhD, University of Texas at Austin, 1993) is the Robert Call/Deloitte Professor in the School of Accountancy at Brigham Young University He teaches taxation at Brigham Young University He received both BS (Summa Cum Laude) and MAcc (tax emphasis) degrees from Brigham Young University before working as a tax consultant for Arthur Young & Co (now Ernst & Young) After his professional work experience, Brian earned his PhD at the University of Texas at Austin In 1996, he was selected as one of two nationwide recipients of the Price Waterhouse Fellowship in Tax Award In 1998, he was a winner of the American Taxation Association and Arthur Andersen Teaching Innovation Award for his work in the classroom; he has also been awarded for his use of technology in the classroom at Brigham Young University Brian researches issues relating to tax information search and professional tax judgment His research has been published in journals such as The Accounting Review, Organizational Behavior and Human Decision Processes, Journal of the American Taxation Association, Behavioral Research in Accounting, Journal of Accounting Education, Journal of Corporate Taxation, and Journal of Accountancy Ben Ayers (PhD, University of Texas at Austin, 1996) holds the Earl Davis Chair in Taxation and is the dean of the Terry College of Business at the University of Georgia He received a PhD from the University of Texas at Austin and an MTA and BS from the University of Alabama Prior to entering the PhD program at the University of Texas, Ben was a tax manager at KPMG in Tampa, Florida, and a contract manager with Complete Health, Inc., in Birmingham, Alabama He is the recipient of 11 teaching awards at the school, college, and university levels, including the Richard B Russell Undergraduate Teaching Award, the highest teaching honor for University of Georgia junior faculty members His research interests include the effects of taxation on firm structure, mergers and acquisitions, and capital markets and the effects of accounting information on security returns He has published articles in journals such as The Accounting Review, Journal of Finance, Journal of Accounting and Economics, Contemporary Accounting Research, Review of Accounting Studies, Journal of Law and Economics, Journal of the American Taxation Association, and National Tax Journal Ben was the 1997 recipient of the American Accounting Association’s Competitive Manuscript Award, the 2003 and 2008 recipient of the American Taxation Association’s Outstanding Manuscript Award, and the 2016 recipient of the American Taxation Association’s Ray M Sommerfeld Outstanding Tax Educator Award Courtesy Brian Spilker Courtesy Ben Ayers iv About the Authors Courtesy John Barrick Courtesy Ed Outslay John Barrick (PhD, University of Nebraska at Lincoln, 1998) is currently an associate professor in the Marriott School at Brigham Young University He served as an accountant at the United States Congress Joint Committee on Taxation during the 110th and 111th Congresses He teaches taxation in the graduate and undergraduate programs at Brigham Young University He received both BS and MAcc (tax emphasis) degrees from Brigham Young University before working as a tax consultant for Price Waterhouse (now PricewaterhouseCoopers) After his professional work experience, John earned his PhD at the University of Nebraska at Lincoln He was the 1998 recipient of the American Accounting Association, Accounting, Behavior, and Organization Section’s Outstanding Dissertation Award John researches issues relating to tax corporate political activity His research has been published in journals such as Organizational Behavior and Human Decision Processes, Contemporary Accounting Research, and Journal of the American Taxation Association Ed Outslay (PhD, University of Michigan, 1981) is a professor of accounting and the Deloitte/ Michael Licata Endowed Professor of Taxation in the Department of Accounting and Information Systems at Michigan State University, where he has taught since 1981 He received a BA from Furman University in 1974 and an MBA and PhD from the University of Michigan in 1977 and 1981 Ed currently teaches graduate classes in corporate taxation, multiunit enterprises, accounting for income taxes, and international taxation In February 2003, Ed testified before the Senate Finance Committee on the Joint Committee on Taxation’s Report on Enron Corporation MSU has honored Ed with the Presidential Award for Outstanding Community Service, Distinguished Faculty Award, John D Withrow Teacher-Scholar Award, Roland H. Salmonson Outstanding Teaching Award, Senior Class Council Distinguished Faculty Award, MSU Teacher-Scholar Award, and MSU’s 1st Annual Curricular Service-Learning and Civic Engagement Award in 2008 Ed received the Ray M Sommerfeld Outstanding Tax Educator Award in 2004 and the Lifetime Service Award in 2013 from the American Taxation Association He has also received the ATA Outstanding Manuscript Award twice, the ATA/Deloitte Teaching Innovations Award, and the 2004 Distinguished Achievement in Accounting Education Award from the Michigan Association of CPAs In 2017, Ed received the American Accounting Association / J Michael and Mary Ann Cook Prize given in “foremost recognition of an individual who consistently demonstrates the attributes of a superior teacher in the discipline of accounting.” Ed has been recognized for his community service by the Greater Lansing Chapter of the Association of Government Accountants, the City of East Lansing (Crystal Award), and the East Lansing Education Foundation He received a National Assistant Coach of the Year Award in 2003 from AFLAC and was named an Assistant High School Baseball Coach of the Year in 2002 by the Michigan High School Baseball Coaches Association About the Authors John Robinson (PhD, University of Michigan, 1981) is the Patricia ’77 and Grant E Sims ’77 Eminent Scholar Chair in Business Prior to joining the faculty at Texas A&M, John was the C Aubrey Smith Professor of Accounting at the University of Texas at Austin, Texas, and he taught at the University of Kansas where he was the Arthur Young Faculty Scholar In 2009– 2010 John served as the Academic Fellow in the Division of Corporation Finance at the Securities and Exchange Commission He has been the recipient of the Henry A Bubb Award for outstanding teaching, the Texas Blazer’s Faculty Excellence Award, and the MPA Council Outstanding Professor Award John also received the 2012 Outstanding Service Award from the American Taxation Association (ATA) and in 2017 was named the Ernst & Young and ATA Ray Sommerfeld Outstanding Educator John served as the 2014–2015 president (elect) of the ATA and is the ATA’s president for 2015–2016 John conducts research in a broad variety of topics involving financial accounting, mergers and acquisitions, and the influence of taxes on financial structures and performance His scholarly articles have appeared in The Accounting Review, The Journal of Accounting and Economics, Journal of Finance, National Tax Journal, Journal of Law and Economics, Journal of the American Taxation Association, The Journal of the American Bar Association, and The Journal of Taxation John’s research was honored with the 2003 and 2008 ATA Outstanding Manuscript Awards In addition, John was the editor of The Journal of the American Taxation Association from 2002–2005 Professor Robinson received his J.D (Cum Laude) from the University of Michigan in 1979, and he earned a PhD in accounting from the University of Michigan in 1981 John teaches courses on individual and corporate taxation and advanced accounting Connie Weaver (PhD, Arizona State University, 1997) is the KPMG Professor of Accounting at Texas A&M University She received a PhD from Arizona State University, an MPA from the University of Texas at Arlington, and a BS (chemical engineering) from the University of Texas at Austin Prior to entering the PhD Program, Connie was a tax manager at Ernst & Young in Dallas, Texas, where she became licensed to practice as a CPA She teaches taxation in the Professional Program in Accounting and the Executive MBA program at Texas A&M University She has also taught undergraduate and graduate students at the University of Wisconsin–Madison and the University of Texas at Austin She is the recipient of several teaching awards, including the 2006 American Taxation Association/Deloitte Teaching Innovations award, the David and Denise Baggett Teaching award, and the college and university level Association of Former Students Distinguished Achievement award in teaching Connie’s current research interests include the effects of tax and financial incentives on corporate decisions and reporting She has published articles in journals such as The Accounting Review, Contemporary Accounting Research, Journal of the American Taxation Association, National Tax Journal, Accounting Horizons, Journal of Corporate Finance, and Tax Notes Connie is the senior editor of The Journal of the American Taxation Association and she serves on the editorial board of Contemporary Accounting Research Ron Worsham (PhD, University of Florida, 1994) is an associate professor in the School of Accountancy at Brigham Young University He teaches taxation in the graduate, undergraduate, MBA, and Executive MBA programs at Brigham Young University He has also taught as a visiting professor at the University of Chicago He received both BS and MAcc (tax emphasis) degrees from Brigham Young University before working as a tax consultant for Arthur Young & Co (now Ernst & Young) in Dallas, Texas While in Texas, he became licensed to practice as a CPA After his professional work experience, Ron earned his PhD at the University of Florida He has been honored for outstanding innovation in the classroom at Brigham Young University Ron has published academic research in the areas of taxpayer compliance and professional tax judgment He has also published legal research in a variety of areas His work has been published in journals such as Journal of the American Taxation Association, The Journal of International Taxation, The Tax Executive, Tax Notes, The Journal of Accountancy, and Practical Tax Strategies Courtesy John Robinson Courtesy Connie Weaver Courtesy Ron Worsham v TEACHING THE CODE IN CONTEXT The bold innovative approach used by McGraw-Hill’s Taxation series is quickly becoming the most popular choice of course materials among instructors and students It’s apparent why the clear, organized, and engaging delivery of content, paired with the most current and robust tax code u pdates, has been adopted by more than 600 schools across the country McGraw-Hill’s Taxation is designed to provide a unique, innovative, and engaging learning experience for students studying taxation The breadth of the topical coverage, the storyline approach to presenting the material, the emphasis on the tax and nontax consequences of multiple parties involved in transactions, and the integration of financial and tax accounting topics make this book ideal for the modern tax curriculum “This text provides broad coverage of important topics and does so in a manner that is easy for students to understand The material is very accessible for students.” Kyle Post – Tarleton State University “Do you want the best tax text? This is the one to use It has a storyline in each chapter that can relate to real life issues.” Leslie A Mostow – University of Maryland, College Park Since the first manuscript was written in 2005, 449 professors have contributed 499 book reviews, in addition to 29 focus groups and symposia Throughout this preface, their comments on the book’s organization, pedagogy, and unique features are a testament to the marketdriven nature of Taxation’s development “I think this is the best book available for introductory and intermediate courses in taxation.” Shane Stinson – University of Alabama vi A MODERN APPROACH FOR TODAY’S STUDENT Spilker’s taxation series was built around the following five core precepts: Storyline Approach: Each chapter begins with a storyline that introduces a set of characters or a business entity facing specific tax-related situations Each chapter’s examples are related to the storyline, providing students with opportunities to learn the code in context Integrated Examples: In addition to providing examples in-context, we provide “What if” scenarios within many examples to illustrate how variations in the facts might or might not change the answers Conversational Writing Style: The authors took special care to write McGraw-Hill’s Taxation in a way that fosters a friendly dialogue between the content and each individual student The tone of the presentation is intentionally conversational—creating the impression of speaking with the student, as opposed to lecturing to the student Superior Organization of Related Topics: McGraw-Hill’s Taxation provides two alternative topic sequences In the McGraw-Hill’s Taxation of Individuals and Business Entities volume, the individual topics generally follow the tax form sequence, with an individual overview chapter and then chapters on income, deductions, investment-related issues, and the tax liability computation The topics then transition into business-related topics that apply to individuals This volume then provides a group of specialty chapters dealing with topics of particular interest to individuals (including students), including separate chapters on home ownership, compensation, and retirement savings and deferred compensation This volume concludes with a chapter covering the taxation of business entities Alternatively, in the Essentials of Federal Taxation volume, the topics follow a more traditional sequence, with topics streamlined (no specialty chapters) and presented in more of a life-cycle approach Real-World Focus: Students learn best when they see how concepts are applied in the real world For that reason, real-world examples and articles are included in “Taxes in the Real World” boxes throughout the book These vignettes demonstrate current issues in taxation and show the relevance of tax issues in all areas of business The in-text examples of how to complete tax returns(is a strength of this text) These help students improve their overall understanding of the material as it moves from something abstract to something tangible the student can produce.” Christine Cheng–Louisiana State University vii A STORYLINE APPROACH THAT RESONATES WITH STUDENTS Each chapter begins with a storyline that introduces a set of characters facing specific tax-related situations This revolutionary approach to teaching tax emphasizes real people facing real tax dilemmas Students learn to apply practical tax information to specific business and personal situations As their situations evolve, the characters are brought further to life Storyline Summary ©Image Source C ourtney has already determined her taxable income Now she’s working on computing her tax liability She Taxpayers: Courtney Wilson, age 40, and Courtney’s mother Dorothy “Gram” Weiss, age 70 Family description: Courtney is divorced with a son, Deron, age 10, and a daughter, Ellen, age 20 Gram is currently residing with Courtney Location: Kansas City, Missouri Employment status: Courtney works as an architect for EWD Gram is retired Filing status: Courtney is head of household Gram is single Current situation: Courtney and Gram have computed their taxable income Now they are trying to determine their tax liability, tax refund, or additional taxes due and whether they owe any payment-related penalties knows she owes a significant amount of regular income tax on her employment and business activities However, she’s not sure how to compute the tax on the qualified dividends she re- ceived from General Electric and is worried that she She’s planning on filing her tax return and paying may be subject to the alternative minimum tax this her taxes on time year Finally, Courtney knows she owes some self- Gram’s tax situation is much more straightforward employment taxes on her business income Courtney She needs to determine the regular income tax on her would like to determine whether she is eligible to taxable income Her income is so low she knows she claim any tax credits, such as the child tax credit for need not worry about the alternative minimum tax, and her two children and education credits, because she she believes she doesn’t owe any self-employment tax paid for a portion of her daughter Ellen’s tuition at Gram didn’t prepay any taxes this year, so she is con- the University of Missouri–Kansas City this year cerned that she might be required to pay an underpay- Courtney is hoping that she has paid enough in taxes ment penalty She also expects to file her tax return and during the year to avoid underpayment penalties pay her taxes by the looming due date “Excellent text! Very readable, easy for students to read and understand Storyline approach and integrated examples make it easy for students to relate to taxpayers and their tax situations.” to be continued Examples Examples are the cornerstone of any textbook covering taxation For this reason, McGraw-Hill’s Taxation authors took special care to create clear and helpful examples that relate to the storyline of the chapter Students learn to refer to the facts presented in the storyline and apply them to other scenarios—in this way, they build a greater base of knowledge through application Many examples also include “What if?” scenarios that add more complexity to the example or explore related tax concepts Sandra Owen – Indianan State University, Bloomington 8-1 2-4 CHAPTER The statute of limitations for IRS assessment can be extended in certain circumstances For example, a six-year statute of limitations applies to IRS assessments if the taxpayer omits items of gross income that exceed 25 percent of the gross income reported on the tax return For fraudulent returns, or if the taxpayer fails to file a tax return, the news is understandably worse The statute of limitations remains open indefinitely in these cases spi18394_ch08_000-051.indd “The text is easy to read and provides many easy-to-follow examples throughout the chapter.” Gloria Jean Stuart – Georgia Southern University viii Tax Compliance, the IRS, and Tax Authorities 3/22/18 9:41 AM Example 2-1 Bill and Mercedes file their 2014 federal tax return on September 6, 2015, after receiving an automatic extension to file their return by October 15, 2015 In 2018, the IRS selects their 2014 tax return for audit When does the statute of limitations end for Bill and Mercedes’s 2014 tax return? Answer: Assuming the six-year and “unlimited” statute of limitation rules not apply, the statute of limitations ends on September 6, 2018 (three years after the later of the actual filing date and the original due date) What if: When would the statute of limitations end for Bill and Mercedes for their 2014 tax return if the couple filed the return on March 22, 2015 (before the original due date of April 15, 2015)? Answer: In this scenario the statute of limitations would end on April 15, 2018, because the later of the actual filing date and the original due date is April 15, 2015 Taxpayers should prepare for the possibility of an audit by retaining all supporting documents (receipts, canceled checks, etc.) for a tax return until the statute of limitations expires After the statute of limitations expires, taxpayers can discard the majority of supporting documents but should still keep a copy of the tax return itself, as well as any documents that may have ongoing significance, such as those establishing the taxpayer’s basis or original investment in existing assets like personal residences and long-term investments LO 2-2 IRS AUDIT SELECTION Why me? This is a recurring question in life and definitely a common taxpayer question after receiving an IRS audit notice The answer, in general, is that a taxpayer’s return is selected for audit because the IRS has data suggesting the taxpayer’s tax return has a high probability of a significant understated tax liability Budget constraints limit the IRS’s ability to audit a majority or even a large minority of tax returns Currently, fewer than percent of all tax returns are audited Thus, the IRS must be strategic in selecting returns for audit in an effort to promote the highest level of voluntary taxpayer compliance and increase tax revenues Specifically, how does the IRS select tax returns for audit? The IRS uses a number of computer programs and outside data sources (newspapers, financial statement disclosures, informants, and other public and private sources) to identify tax returns that may have an understated tax liability Common computer initiatives include the DIF (Discriminant Function) system, the document perfection program, and the information matching program The most important of these initiatives is the DIF system The DIF system assigns a score to each tax return that represents the probability the tax liability on the return has been underre- THE PEDAGOGY YOUR STUDENTS NEED TO PUT THE CODE IN CONTEXT CHAPTER Taxes in the Real World Taxes in the Real World are short boxes used throughout the book to demonstrate the real-world use of tax concepts Current articles on tax issues, the real-world application of chapter-specific tax rules, and short vignettes on popular news about tax are some of the issues covered in Taxes in the Real World boxes “The Spilker text makes tax easy for students to understand It integrates great real-world examples so students can see how topics will be applied in practice The integration of the tax form and exhibits of the tax forms in the text are outstanding.” HOW TO CALCULATE A TAX TAXES IN THE REAL WORLD An Introduction to Tax Tax Policy: Republicans versus Democrats Oliver Wendell Holmes said “taxes are the price we pay to live in a civilized society.” Both Democrats and Republicans desire the same things: a civilized society and a healthy economy However, neither party can agree on what defines a civilized society or which path best leads to a healthy economy The U.S national debt is $20 trillion dollars and growing, yet the only thing we might agree on is that something has gone wrong Regardless of which party or candidate you support, each party’s agenda will affect your income and taxes in various ways To explore the divide, let’s examine excerpts from each party’s National Platform from our most recent presidential election (2016) of taxes Democrats will claw back tax breaks for companies that ship jobs overseas, eliminate tax breaks for big oil and gas companies, and crack down on inversions and other methods companies use to dodge their tax responsibilities We will then use the revenue raised from fixing the corporate tax code to reinvest in rebuilding America and ensuring economic growth that will lead to millions of good-paying jobs.” “We will ensure those at the top contribute to our country’s future by establishing a multimillionaire surtax to ensure millionaires and billionaires pay their fair share In addition, we will shut down the “private tax system” for those at the top, immediately close egregious loopholes Republicans like those enjoyed by hedge fund managers, “We are the party of a growing economy that restore fair taxation on multimillion dollar esgives everyone a chance in life, an opportunity to tates, and ensure millionaires can no longer learn, work, and realize the prosperity freedom pay a lower rate than their secretaries At a makes possible.” time of near-record corporate profits, slow “Government cannot create prosperity, wage growth, and rising costs, we need to offer though government can limit or destroy it Pros- tax relief to middle-class families—not those at perity is the product of self-discipline, enterprise, the top.” saving and investment by individuals, but it is not “We will offer tax relief to hard working, middlean end in itself Prosperity provides the means by class families for the cost squeeze they have which citizens and their families can maintain faced for years from rising health care, childcare, their independence from government, raise their education, andIntroduction other expenses.” https://www CHAPTER An to Tax 1-5 children by their own values, practice their faith, democrats.org/party-platform#preamble and build communities of cooperation and muConclusion tual respect.” LO 1-3 “Republicans consider the establishment of a Each party fundamentally believes the governpro-growth tax code a moral imperative More ment should create/maintain cities and states that than any other public policy, the way government form a civilized society, and that government raises revenue—how much, at what rates, under should foster a healthy economy However, they what circumstances, from whom, and for whom— choose very different paths to reach this objechas the greatest impact on our economy’s perfor- tive Democrats want to raise taxes on the mance It powerfully influences the level of wealthy and create government programs which economic growth and job creation, which trans- cost more money, while Republicans wish to lates into the level of opportunity for those who lower taxes and decrease government size and would otherwise be left behind.” spending Both motives pure; FACTS however, curTHEareKEY “A strong economy is one key to debt reduc- rent and cumulative deficits indicate that current How totoCalculate a Tax tion, but spending restraint is a necessary compo- revenue is insufficient meet government nent that must be vigorously pursued.” https://www spending Solving these problems require • Tax = Tax base ×willTax rate gop.com/platform/restoring-the-american-dream/ civil discourse, education and research/informa• realistic, tax base defines what tion in order to find The effective solutions its simplest form,Tech the amount of tax equals the tax base multiplied by the tax rate: – Kristen In Bigbee, Texas University Eq 1-1 Tax = Tax Base × Tax Rate The Key Facts The Key Facts provide quick synopses of the critical pieces of information presented throughout each chapter The tax base defines what is actually taxed and is usually expressed in monetary terms, whereas the tax rate determines the level of taxes imposed on the tax base and is usually expressed as a percentage For example, a sales tax rate of percent on a purchase of $30 yields a tax of $1.80 ($1.80 = $30 × 06) Federal, state, and local jurisdictions use a large variety of tax bases to collect tax is actually taxed and is Democrats Some common tax bases (and related taxes) include taxable income (federal andRepublicans: state https://www.gop.com/platform/restoring-thea time of massive income and wealth inusually expressed in american-dream/ income taxes), purchases (sales tax), real estate “At values (real estate tax), and personal equality, we believe the wealthiest Americans Democrats: https://www.democrats.org/party-platform# monetary terms and largest corporations must pay their fair share preamble property values (personal property tax) • The tax rate determines Different portions of a tax base may be taxed at different rates A single tax applied the level of taxes imposed to an entire base constitutes a flat tax In the case ofIngraduated taxes, is of divided on the taxpolitical base anddecisions is ususummary, taxes affect the manybase aspects personal, business, and expressed as a decisions into a series of monetary amounts, or brackets, Developing and each asuccessive bracket is taxed at allow a you ally solid understanding of taxation should to make informed 2-7 CHAPTER Tax Compliance, the IRS, and Tax Authorities in these areas.rate Thus, Margaret can take comfort that her semester will likely prove useful to percentage different (gradually higher or gradually lower) percentage personally Who knows? Depending on her interest in business, investment, • Different portions ofretirement a tax Calculating some taxes—income taxes forher individuals or corporations, for examEXHIBIT 2-2 IRS Appeals/Litigation Process planning, and the like, she may ultimately decide to pursue a career taxation Exhibits base in may be taxed at ple—can be quite complex Advocates of flat taxes argue process should be IRS Exam that1b the 1a Agree with proposed Disagree with different rates adjustment proposed adjustment simpler But as we’ll see throughout the text, most of the difficulty in calculating a tax Today’s students are visual learners, and rests in determining the tax base, not the tax rate Indeed, there are only three basic tax Pay Taxes Due 30-Day Letter McGraw-Hill’s Taxation rate understands this progressive, structures (proportional, and regressive), and each can be mastered difficulty student need by making without use ofmuch clear and engaging charts, diagrams, and tabular DIFFERENT WAYS TO MEASURE TAX RATES demonstrations of key material spi18394_ch01_000-029.indd 3a Agree with proposed adjustment 2a Request appeals Appeals Conference 2b No taxpayer response 3b Disagree with proposed adjustment File Suit in U.S District Court or U.S Court of File Claim for IRS denies Refund with the IRS Federal Claims structures, Before we discuss the alternative tax rate refund claim let’s first define 4b Pay taxthree different tax rates that will be useful in contrasting the different tax rate structures: the marginal, average, and effective tax rates 4a Do not pay tax; “It is easily accessible to students as it is Petition Tax Court The marginal tax rate is the tax rate that applies to the next additional increment of Tax Court written in easy-to-understand language, a taxpayer’s taxable income (or deductions) Specifically, 90-Day Letter and contains sufficient examples to illusMarginal Tax Rate = trate complicated tax concepts and (New Total Tax − Old Total Tax) ΔTax* Eq 1-2 = calculations.” ΔTaxable Income (New Taxable Income − Old Taxable Income) IRS Exam: ©Imageroller/Alamy Stock Photo; Supreme Court: ©McGraw-Hill Education/Jill Braaten, photographer (also known as a statutory notice of deficiency) explains that the taxpayer has 90 days to either (1) pay the proposed deficiency or (2) file a petition in the U.S Tax Court to hear the case.8 The U.S Tax Court is a national court whose judges are tax experts who hear only tax cases If the taxpayer would like to litigate the case but prefers it to be heard in the local U.S District Court or the U.S Court of Federal Claims, the taxpayer must pay the tax deficiency first, then request a refund from the IRS, and then sue the IRS for refund in the court after the IRS denies the refund claim *Δ means change in Machiavelli Chao – University of California, Irvine: The Paul where “old” refers to the current tax and “new” refers to the revised tax after incorporating the additional income (or deductions) in question In graduated income tax systems, Merage School of Business that is low on technical merit but high on emotional appeal, a jury trial in the local U.S District Court may be the best option What happens after the taxpayer’s case has been decided in a trial court? The process may not be quite finished After the trial court’s verdict, the losing party has the right to request one of the 13 U.S Circuit Courts of Appeals to hear the case Exhibit 2-3 depicts the specific appellant courts for each lower-level court Both the U.S Tax Court and local U.S District Court cases are appealed to the specific U.S Circuit Court of Appeals based on the taxpayer’s residence.9 Cases litigated in Alabama, Florida, and Georgia, for example, appeal to the U.S Circuit Court of Appeals for the 11th Circuit, whereas those tried in Louisiana, Mississippi, and Texas appeal to the 5th Circuit In contrast, all U.S Court of Federal Claims cases appeal to the U.S Circuit Court of Appeals for the Federal additional income (deductions) can push a taxpayer into a higher (lower) tax bracket, thus changing the marginal tax rate If the taxpayer lacks the funds to pay the assessed tax, there is legitimate doubt as to whether the taxpayer owes part or all of the assessed tax, or collection of the tax would cause the taxpayer economic hardship or be unfair or inequitable, the taxpayer can request an offer in compromise with the IRS to settle the tax liability for less than the full amount assessed by completing Form 656 Decisions rendered by the U.S Tax Court Small Claims Division cannot be appealed by the taxpayer or the IRS Example 1-3 ix Margaret’s parents, Bill and Mercedes, file a joint tax return They have $160,000 of taxable income this year (after all tax deductions) Assuming the following federal tax rate schedule applies, how much federal income tax will they owe this year?4 (continued on page 1-6) spi18394_ch02_000-035.indd 2/2/18 10:45 AM 1-3 Appendix C Comprehensive Tax Return Problems Ten additional Comprehensive Tax Return problems—covering individual, corporation, partnership, and S corporation tax returns—can be found in the Connect Library INDIVIDUAL TAX RETURN PROBLEM Required: ∙ Use the following information to complete Keith and Jennifer Hamilton’s 2017 federal income tax return If any information is missing, use reasonable assumptions to fill in the gaps ∙ Form 1040, supporting schedules, and instructions to the forms and schedules can be found at the IRS website (www.irs.gov) Facts: Keith Hamilton is employed as an airline pilot for Flyby Airlines in Las Vegas, Nevada Jennifer is employed as a teacher’s assistant at Small World Elementary School, in Henderson, Nevada Keith and Jennifer live in a home they purchased this year Keith and Jennifer have three children who lived with them all year, Joshua (17), Danielle (14), and Sara (10) Keith and Jennifer provided the following personal information: ∙ Keith and Jennifer not want to contribute to the presidential election campaign ∙ Keith and Jennifer not claim itemized deductions ∙ Keith and Jennifer live at 3678 Blue Sky Drive, Henderson, Nevada 89052 ∙ Keith’s birthday is 10/12/1972 and his Social Security number is 535-22-4466 ∙ Jennifer’s birthday is 7/16/1975 and her Social Security number is 535-44-2255 ∙ Joshua’s birthday is 6/30/2000 and his Social Security number is 454-54-5454 ∙ Danielle’s birthday is 8/12/2003 and her Social Security number is 343-43-4343 ∙ Sara’s birthday is 5/13/2007 and her Social Security number is 232-32-3232 C Appendix C Keith received the following Form W-2 for 2017 from Flyby Airlines 22222 Void a Employee’s social security number 535-22-4466 For Official Use Only OMB No 1545-0008 b Employer identification number (EIN) ▶ Wages, tips, other compensation Federal income tax withheld Social security wages Social security tax withheld Medicare wages and tips Medicare tax withheld 163,645.00 91-0001002 c Employer’s name, address, and ZIP code 127,200.00 Flyby Airlines 375 West Flight Blvd Las Vegas, NV 89119 7,886.40 178,645.00 2,590.35 Social security tips Allocated tips Verification code d Control number e Employee’s first name and initial 31,000.00 10 Dependent care benefits Suff 11 Nonqualified plans Last name 13 Keith Hamilton 3678 Blue Sky Drive Henderson, NV 89052 Statutory employee Retirement plan 12a See instructions for box 12 C o d e Third-party sick pay X 14 Other D 15,000 12b C o d e 12c C o d e 12d C o d e f Employee’s address and ZIP code 15 State Form 16 State wages, tips, etc Employer’s state ID number NV 987654321 W-2 163,645.00 Wage and Tax Statement 17 State income tax 18 Local wages, tips, etc 19 Local income tax 20 Locality name 0.00 2017 Department of the Treasury—Internal Revenue Service For Privacy Act and Paperwork Reduction Act Notice, see the separate instructions Copy A For Social Security Administration — Send this entire page with Form W-3 to the Social Security Administration; photocopies are not acceptable Cat No 10134D Do Not Cut, Fold, or Staple Forms on This Page Source: Form W-2, Department of the Treasury - Internal Revenue Service, 2017 Jennifer received the following Form W-2 for 2017 from Small World Elementary School 22222 Void a Employee’s social security number 535-44-2255 For Official Use Only OMB No 1545-0008 b Employer identification number (EIN) ▶ Wages, tips, other compensation Federal income tax withheld Social security wages Social security tax withheld Medicare wages and tips Medicare tax withheld c Employer’s name, address, and ZIP code 39,925.00 Small World Elementary School 333 Tiny Tot Lane Henderson, NV 89053 2,475.35 39,925.00 578.90 Social security tips Allocated tips Verification code d Control number e Employee’s first name and initial 5,524.00 36,825.00 91-0001003 10 Dependent care benefits Suff 11 Nonqualified plans Last name 13 Jennifer Hamilton 3678 Blue Sky Drive Henderson, NV 89052 Statutory employee Retirement plan 12a See instructions for box 12 C o d e Third-party sick pay X 14 Other D 3,100 12b C o d e 12c C o d e 12d C o d e f Employee’s address and ZIP code 15 State NV Form Employer’s state ID number 123456789 W-2 16 State wages, tips, etc 36,825.00 Wage and Tax Statement 17 State income tax 18 Local wages, tips, etc 19 Local income tax 20 Locality name 0.00 2017 Copy A For Social Security Administration — Send this entire page with Form W-3 to the Social Security Administration; photocopies are not acceptable Department of the Treasury—Internal Revenue Service For Privacy Act and Paperwork Reduction Act Notice, see the separate instructions Cat No 10134D Do Not Cut, Fold, or Staple Forms on This Page Source: Form W-2, Department of the Treasury - Internal Revenue Service, 2017 During 2017, Keith and Jennifer received $550 in interest from Las Vegas municipal bonds, $1,070 interest from U.S Treasury bonds, and $65 from their savings account at SCD Credit Union Keith and Jennifer are joint owners of the Las Vegas city bonds and the U.S Treasury bonds They have a joint savings account at SCD Credit Union C-1 C-2 Appendix C On January 21, 2017, Jennifer was involved in a car accident Because the other driver was at fault, the other driver’s insurance company paid Jennifer $1,350 for medical expenses relating to her injuries from the accident and $300 for emotional distress from the accident She received payment on March 15, 2017 Keith’s father died on November 15, 2016 Keith received a $100,000 death benefit from his father’s life insurance policy on February 8, 2017 On February 15, 2017, Keith hurt his arm on a family skiing trip in Utah and was unable to fly for two weeks He received $4,000 for disability pay from his disability insurance policy He received the check on March 2, 2017 Flyby Airlines paid $600 in premiums on this policy during 2017 The disability insurance policy premiums are paid for by Flyby Airlines as a fully taxable fringe benefit to Keith (the premiums paid on his behalf are included in Keith’s compensation amount on his W-2) Jennifer’s grandmother died on March 10, 2017, leaving Jennifer with an inheritance of $30,000 (She received the inheritance on May 12, 2017.) Flyby Airlines had space available on its Long Island, New York, flight and provided Keith, Jennifer, and their three children with free flights so they could attend the funeral The value of the ticket for each passenger was $600 On April 1, 2017, Jennifer slipped in the Small World Elementary lunchroom and injured her back Jennifer received $1,200 in worker’s compensation benefits because her work-related injury caused her to miss two weeks of work She also received a $2,645 reimbursement for medical expenses from the health insurance company Small World Elementary pays the premiums for Jennifer’s health insurance policy as a nontaxable fringe benefit 10 On May 17, 2017, Keith and Jennifer received a federal income tax refund of $975 from their 2016 federal income tax return 11 On June 5, 2017, Keith and Jennifer sold their home in Henderson, Nevada, for $510,000 (net of commissions) Keith and Jennifer purchased the home 11 years ago for $470,000 On July 12, 2017, they bought a new home for $675,000 12 On July 25, 2017, Keith’s aunt Beatrice gave Keith $18,000 because she wanted to let everyone know that Keith is her favorite nephew 13 On September 29, 2017, Jennifer won an iPad valued at $500 in a raffle at the annual fair held at Joshua’s high school 14 Keith and Jennifer have qualifying insurance for purposes of the the Affordable Care Act (ACA) INDIVIDUAL TAX RETURN PROBLEM Required: ∙ Use the following information to complete Johnelle and Latoya Henry’s 2017 federal income tax return If any information is missing, use reasonable assumptions to fill in the gaps ∙ You may need the following forms to complete the project: Form 1040 and Schedule A The forms, schedules, and instructions can be found at the IRS website (www.irs.gov) The instructions can be helpful in completing the forms Facts: Johnelle Henry is employed as a human resources manager for Toys Unlimited, Inc., and Latoya is a financial planner for her mother’s company, Long-term Investments, Inc., a full-service wealth-planning firm They provide the following information: ∙ They both want to contribute to the presidential election campaign ∙ They live at 9876 Old Waverly, Charleston, South Carolina 29401 Appendix C ∙ Johnelle’s birthday is 7/17/1965 and his Social Security number is 555-12-6789 ∙ Latoya’s birthday is 9/11/1967 and her Social Security number is 987-65-4321 ∙ Johnelle and Latoya not have any foreign bank accounts or trusts Johnelle received a Form W-2 from Toys Unlimited, Inc that contained the following information: ∙ Line Wages, tips, other compensation ∙ Line Federal income tax withheld ∙ Line Social Security wages ∙ Line Social Security tax withheld ∙ Line Medicare wages and tips ∙ Line Medicare tax withheld ∙ Line 17 State income tax $45,000 7,500 45,000 2,790 45,000 653 2,200 Latoya received a Form W-2 from Long-term Investments, Inc., that contained the following information: ∙ Line Wages, tips, other compensation ∙ Line Federal income tax withheld ∙ Line Social Security wages ∙ Line Social Security tax withheld ∙ Line Medicare wages and tips ∙ Line Medicare tax withheld ∙ Line 17 State income tax $85,000 12,500 85,000 5,270 85,000 1,233 4,200 Johnelle and Latoya incurred the following medical expenses for the year: ∙ Transportation to Chicago for Johnelle’s cancer treatment ∙ Unreimbursed hospital charges for Johnelle ∙ Unreimbursed prescription drug charges for Johnelle and Latoya ∙ Unreimbursed physician charges for Johnelle and Latoya ∙ Unreimbursed prescription glasses for Latoya ∙ Laser hair treatment for Latoya (so that she will no longer need to shave her legs) 2,000 miles $6,500 1,750 2,200 150 2,000 Johnelle and Latoya paid $12,000 of interest payments on their primary residence (acquisition debt of $225,000) They also paid $1,750 of interest expense on Latoya’s car loan and $500 of interest on their Visa card Johnelle and Latoya paid $4,000 of real estate taxes on their home and $1,000 of real estate tax on a vacant lot they purchased with the hope of building their dream home in the future They also paid $3,000 in sales tax on Latoya’s car and other purchases and $1,000 of ad valorem tax on their cars Johnelle and Latoya made the following contributions this year: ∙ American Red Cross ∙ United Way ∙ St Joseph’s Catholic Church ∙ Food for the family of Hannah Barbara (a neighbor who suffered a tragic car accident this past year) ∙ Stock transfer to the University of South Carolina (originally purchased for $1,000 in 2005) $ 200 150 8,000 225 750 C-3 C-4 Appendix C Johnelle won $5,000 in the state lottery He has been playing the lottery for years [$10 in lottery tickets every week ($520 in total) that he saves to keep track of the numbers he plays] Johnelle and Latoya have qualifying insurance for purposes of the Affordable Care Act (ACA) INDIVIDUAL TAX RETURN PROBLEM Required: ∙ Use the following information to complete Rhonda Hill’s 2017 federal income tax return If any information is missing, use reasonable assumptions to fill in the gaps ∙ The forms, schedules, and instructions can be found at the IRS website (www.irs.gov) The instructions can be helpful in completing the forms Facts: Rhonda Hill (unmarried) is employed as an office manager at the main office of Carter and Associates CPA firm Rhonda lives in a home she purchased 20 years ago Rhonda’s older cousin Mabel Wright lives with Rhonda in the home Mabel is retired and receives $2,400 of Social Security payments each year Mabel is able to save this money because Rhonda provides all of Mabel’s support Rhonda also provided the following information: ∙ Rhonda does not want to contribute to the presidential election campaign ∙ Rhonda lives at 1234 Blue Ridge Way, Tulsa, Oklahoma 74101 ∙ Rhonda’s birthday is 12/18/1952 and her Social Security number is 335-67-8910 ∙ Mabel’s birthday is 11/2/1944 and her Social Security number is 566-77-8899 ∙ Rhonda does not have any foreign bank accounts or trusts ∙ Rhonda has qualifying insurance for purposes of the Affordable Care Act (ACA) Rhonda received a Form W-2 from Carter and Associates (her employer) that contained the following information: ∙ Line Wages, tips, other compensation ∙ Line Federal income tax withheld ∙ Line Social Security wages ∙ Line Social Security tax withheld ∙ Line Medicare wages and tips ∙ Line Medicare tax withheld ∙ Line 16 State wages, tips, etc ∙ Line 17 State income tax ∙ Carter and Associates address is 1234 CPA Way Tulsa, Oklahoma 74101; its FEIN is 91:0001002; and its State ID number is 123456678 $72,000 9,300 72,000 4,464 72,000 1,044 72,000 2,700 Rhonda received $250 in interest from Tulsa City bonds, $120 interest from IBM bonds, and $15 from her savings account at UCU Credit Union She also received a $460 dividend from Huggies Company and $500 from Bicker Corporation Both dividends are qualified dividends Rhonda sold 200 shares of DM stock for $18 a share on June 15, 2017 She purchased the stock on December 12, 2012, for $10 a share She also sold 50 shares of RSA stock for $15 a share on October 2, 2017 She purchased Appendix C the stock for $65 a share on February 2, 2017 Stock basis amounts have been reported to the IRS The following is a record of the medical expenses that Rhonda paid for herself during the year The amounts reported are amounts she paid in excess of insurance reimbursements Rhonda drove 210 miles for medical purposes in 2017 Insurance premiums $3,700 Prescription medications 100 Over-the-counter medications 250 Doctor and dentist visits 1,450 Eyeglasses 300 Physical therapy 200 Rhonda paid $2,800 in mortgage interest during the year to UCU credit union (reported to her on Form 1098) She also paid $1,200 in real property taxes during the year Rhonda contributed $2,350 to Heavenly Church during the year Heavenly Church’s address is 1342 Religion Way, Tulsa, Oklahoma 74101 INDIVIDUAL TAX RETURN PROBLEM Required: ∙ Use the following information to complete Phillip and Claire Dunphy’s 2017 federal income tax return If any information is missing, use reasonable assumptions to fill in the gaps Ignore the alternative minimum tax for this problem ∙ Any required forms, schedules, and instructions can be found at the IRS website (www.irs.gov) The instructions can be helpful in completing the forms Facts: Phillip and Claire are married and file a joint return Phillip is self-employed as a real estate agent, and Claire is a flight attendant Phillip and Claire have three dependent children All three children live at home with Phillip and Claire for the entire year The Dunphys provide you with the following additional information: ∙ The Dunphys not want to contribute to the presidential election campaign ∙ The Dunphys live at 3701 Brighton Avenue, Los Angeles, California 90018 ∙ Phillip’s birthday is 11/5/1971 and his Social Security number is 321-XX-5766 ∙ Claire’s birthday is 5/12/1974 and her Social Security number is 567-XX-1258 ∙ Haley’s birthday is 11/6/2005 and her Social Security number is 621-XX-7592 ∙ Alex’s birthday is 2/1/2007 and her Social Security number is 621-XX-8751 ∙ Luke’s birthday is 12/12/2011 and his Social Security number is 621-XX-9926 ∙ The Dunphys not have any foreign bank accounts or trusts Claire is a flight attendant for Western American Airlines (WAA), where she earned $57,000 in salary WAA withheld federal income tax of $6,375, state income tax of $1,800, Los Angeles city income tax of $675, Social Security tax of $3,600, and Medicare tax of $825 Phillip and Claire received $300 of interest from State Savings Bank on a joint account They also received a qualified dividend of $395 on jointly owned stock in Xila Corporation C-5 C-6 Appendix C Phillip’s full-time real estate business is named “Phillip Dunphy Realty.” His business is located at 645 Grove Street, Los Angeles, California 90018, and his employer identification number is 93-3488888 Phillip’s gross receipts during the year were $730,000 Phillip uses the cash method of accounting for his business Phillip’s business expenses are as follows: Advertising Professional dues Professional journals Employee wages Insurance on office contents Accounting services Miscellaneous office expense Utilities and telephone Payroll taxes Depreciation $ 5,000 800 200 48,000 1,120 2,100 500 3,360 3,600 To be calculated On March 20, Phillip moved his business out of the old offices at 1103 Allium Lane into a newly constructed and equipped office on Grove Street Phillip sold the old office building and all its furnishings Phillip’s expenditures for the new office building are as follows: Date Acquired Asset Cost 3/20 3/20 3/20 4/1 6/1 Land Office building Furniture Computer system Artwork $ 300,000 2,500,000 200,000 350,000 150,000 Phillip computes his cost recovery allowance using MACRS He would like to use the §179 immediate expensing, but he has elected to not claim any bonus depreciation Phillip has never claimed §179 or bonus depreciation before The assets Phillip sold on March 20 are as follows: Date Acquired Asset Sales Price 5/1/11 5/1/11 7/1/11 8/13/13 4/12/14 5/13/15 Office building Land Furniture Furniture Office equipment Computers Original Cost Accumulated Depreciation as of Beginning of the Year $940,000 $900,000 200,000 100,000 50,000 239,000 10,000 324,000 100,000 120,000 30,000 50,000 $129,825 0 206,998 222,782 67,524 10,000 Phillip has never sold any assets relating to his business before this transaction The Dunphys sold 60 shares of Fizbo Corporation common stock on September for $65 a share (minus a $50 total commission) The Dunphys purchased the stock on November 8, 2016, for $90 a share They also sold a painting for $13,000 on March Claire purchased the painting for $20,050 on September 1, 2010, as an investment The Dunphys filed their 2016 federal, state, and local returns on April 13, 2017 They paid the following additional 2016 taxes with their returns: federal income taxes of $630, state income taxes of $250, and city income taxes of $75 The Dunphys made timely estimated federal income tax payments of $17,000 each quarter during 2017 They also made estimated state income tax payments of Appendix C $1,000 each quarter and estimated city income tax payments of $300 each quarter The Dunphys made all fourth-quarter payments on December 31, 2017 They would like to receive a refund for any overpayments Phillip and Claire have qualifying insurance for purposes of the Affordable Care Act (ACA) INDIVIDUAL TAX RETURN PROBLEM Required: ∙ Use the following information to complete Armando and Lourdes Gonzales’s 2017 federal income tax return If any information is missing, use reasonable assumptions to fill in the gaps ∙ You may need the following forms and schedules to complete the project: Form 1040, Schedule A, Schedule B, Schedule C, Schedule D, Schedule E, Schedule SE, Form 4562 (for the dental practice), Form 4562 (for the rental property), Form 4797, Form 8863, and Form 8949 The forms, schedules, and instructions can be found at the IRS website (www.irs.gov) The instructions can be helpful in completing the forms Facts: Armando Z and Lourdes K Gonzales are married and file a joint return Armando is self-employed as a dentist, and Lourdes is a college professor Armando and Lourdes have three children The oldest is Ricardo, who lives at home Ricardo is a law student at the University of Cincinnati and worked part time during the year, earning $1,500, which he spent for his own support Armando and Lourdes provided $6,000 toward Ricardo’s support (including $4,000 for Ricardo’s fall tuition) They also provided over half the support of their daughter, Selena, who is a full-time student at Edgecliff College in Cincinnati Selena worked part time as an independent contractor during the year, earning $3,200 Selena lived at home until she was married in December 2017 She filed a joint return with her husband, Tony, who earned $20,000 during the year Felipe is the youngest and lived in the Gonzales’s home for the entire year The Gonzaleses provide you with the following additional information: ∙ Armando and Lourdes would like to take advantage on their return of any educational expenses paid for their children ∙ The Gonzaleses not want to contribute to the presidential election campaign ∙ The Gonzaleses live at 621 Franklin Avenue, Cincinnati, Ohio 45211 ∙ Armando’s birthday is 3/5/1959 and his Social Security number is 333-45-6666 ∙ Lourdes’s birthday is 4/24/1962 and her Social Security number is 566-77-8888 ∙ Ricardo’s birthday is 11/6/1994 and his Social Security number is 576-18-7928 ∙ Selena’s birthday is 2/1/1998 and her Social Security number is 575-92-4321 ∙ Felipe’s birthday is 12/12/2005 and his Social Security number is 613-97-8465 ∙ The Gonzaleses not have any foreign bank accounts or trusts Lourdes is a lecturer at Xavier University in Cincinnati, where she earned $30,000 The university withheld federal income tax of $3,375, state income tax of $900, Cincinnati city income tax of $375, $1,860 of Social Security tax, and $435 of Medicare tax She also worked part of the year for Delta Airlines Delta paid her $10,000 in salary, and withheld federal income tax of $1,125, state income tax of $300, Cincinnati city income tax of $125, Social Security tax of $620, and Medicare tax of $145 The Gonzaleses received $800 of interest from State Savings Bank on a joint account They received interest of $1,000 on City of Cincinnati bonds they bought in January with the proceeds of a loan from Third National Bank of Cincinnati They C-7 C-8 Appendix C paid interest of $1,100 on the loan Armando received a dividend of $540 on General Bicycle Corporation stock he owns Lourdes received a dividend of $390 on Acme Clothing Corporation stock she owns Armando and Lourdes received a dividend of $865 on jointly owned stock in Maple Company All of the dividends received in 2017 are qualified dividends Armando practices under the name “Armando Z Gonzales, DDS.” His business is located at 645 West Avenue, Cincinnati, Ohio 45211, and his employer identi fication number is 01-2222222 Armando’s gross receipts during the year were $111,000 Armando uses the cash method of accounting for his business Armando’s business expenses are as follows: Advertising Professional dues Professional journals Contributions to employee benefit plans Malpractice insurance Fine for overbilling State of Ohio for work performed on welfare patient Insurance on office contents Interest on money borrowed to refurbish office Accounting services Miscellaneous office expense Office rent Dental supplies Utilities and telephone Wages Payroll taxes $ 1,200 490 360 2,000 3,200 5,000 720 600 2,100 388 12,000 7,672 3,360 30,000 2,400 In June, Armando decided to refurbish his office This project was completed and the assets placed in service on July Armando’s expenditures included $8,000 for new office furniture, $6,000 for new dental equipment (seven-year recovery period), and $2,000 for a new computer Armando elected to compute his cost recovery allowance using MACRS He did not elect to use §179 immediate expensing, and he chose to not claim any bonus depreciation Lourdes’s mother, Maria, died on July 2, 2012, leaving Lourdes her entire estate Included in the estate was Maria’s residence (325 Oak Street, Cincinnati, Ohio 45211) Maria’s basis in the residence was $30,000 The fair market value of the residence on July 2, 2012, was $155,000 The property was distributed to Lourdes on January 1, 2013 The Gonzaleses have held the property as rental property and have managed it themselves From 2013 until June 30, 2017, they rented the house to the same tenant The tenant was transferred to a branch office in California and moved out at the end of June Since they did not want to bother finding a new tenant, Armando and Lourdes sold the house on June 30, 2017 They received $140,000 for the house and land ($15,000 for the land and $125,000 for the house), less a percent commission charged by the broker They had depreciated the house using the MACRS rules and conventions applicable to residential real estate To compute depreciation on the house, the Gonzaleses had allocated $15,000 of the property’s basis to the land on which the house is located The Gonzaleses collected rent of $1,000 a month during the six months the house was occupied during the year They incurred the following related expenses during this period: Property insurance Property taxes Maintenance Depreciation (to be computed) $500 800 465 ? Appendix C The Gonzaleses sold 200 shares of Capp Corporation stock on September 3, 2017, for $42 a share (minus a $50 commission) The Gonzaleses received the stock from Armando’s father on June 25, 1981, as a wedding present Armando’s father originally purchased the stock for $10 per share on January 1, 1969 The stock was valued at $14.50 per share on the date of the gift No gift tax was paid on the gift Armando and Lourdes have given you a file containing the following receipts for expenditures during the year: Prescription medicine and drugs (net of insurance reimbursement) Doctor and hospital bills (net of insurance reimbursement) Penalty for underpayment of last year’s state income tax Real estate taxes on personal residence Interest on home mortgage (paid to Home State Savings & Loan) Interest on credit cards (consumer purchases) Cash contribution to St Matthew’s church Payroll deductions for Lourdes’s contributions to the United Way $ 376 2,468 15 4,762 8,250 595 3,080 150 The Gonzaleses filed their 2016 federal, state, and local returns on April 12, 2017 They paid the following additional 2016 taxes with their returns: federal income taxes of $630, state income taxes of $250, and city income taxes of $75 The Gonzaleses made timely estimated federal income tax payments of $1,500 each quarter during 2017 They also made estimated state income tax payments of $300 each quarter and estimated city income tax payments of $160 each quarter The Gonzaleses made all fourth-quarter payments on December 31, 2017 They would like to receive a refund for any overpayments 10 Armando and Lourdes have qualifying insurance for purposes of the Affordable Care Act (ACA) INDIVIDUAL TAX RETURN PROBLEM Required: ∙ Use the following information to complete Paige Turner’s 2017 federal income tax return If any information is missing, use reasonable assumptions to fill in the gaps ∙ Any required forms, schedules, and instructions can be found at the IRS website (www.irs.gov) The instructions can be helpful in completing the forms Facts: Paige Turner is single and has two children from her previous marriage Ali lives with Paige, and Paige provides more than half of her support Leif lives with his father, Will (Leif lived with Will for all of 2017) Will provides more than half of Leif’s support Paige provides you with the following additional information: ∙ She uses the cash method of accounting and a calendar year for reporting ∙ She wishes to contribute to the presidential election campaign ∙ Paige lives at 523 Essex Street, Bangor, Maine 04401 ∙ Paige’s birthday is May 31, 1979 ∙ Ali’s birthday is October 5, 2008 ∙ Leif’s birthday is December 1, 2006 ∙ Paige’s Social Security number is 007-XX-4727 ∙ Ali’s Social Security number is 005-XX-7232 ∙ Leif’s Social Security number is 004-XX-3419 C-9 C-10 Appendix C ∙ Will’s Social Security number is 006-XX-6333 ∙ She does not have any foreign bank accounts or trusts Paige is employed as a nuclear engineer with Atom Systems Consultants, Inc (ASCI) ASCI’s federal employer identification number is 79-1234466 Paige’s pay stubs indicate that she had $7,230 withheld in federal taxes, $4,987 in state taxes, $4,495 in Social Security taxes, and $1,051 in Medicare taxes ASCI has an extensive fringe benefits program for its employees Paige earned salary of $70,000 (before subtracting her 401(k) and flexible spending plan contributions) She contributed $7,000 to her 401(k) account, and she contributed $2,500 to her flexible spending account ASCI paid $397 of whole life insurance premiums to cover Paige’s personal whole life insurance policy ASCI also paid health club dues of $900 to a nearby health club on Paige’s behalf Taking advantage of ASCI’s educational assistance program, during the fall Paige enrolled in two graduate engineering classes at a local college ASCI paid her tuition, fees, and other course-related costs of $2,300 Paige received free parking in the company’s security garage that would normally cost $200 per month Paige manages the safety program for ASCI In recognition of her superior handling of three potential crises during the year, Paige was awarded the Employee Safety Award on December 15 The cash award was $500 On January 15, 2017, Paige’s father died From her father’s estate, she received stock valued at $30,000 (his basis was $12,000) and her father’s house valued at $90,000 (his basis in the house was $55,000) Paige owns several other investments and in February 2018 received a statement from her brokerage firm reporting the interest and dividends earned on the investments for 2017 (See Exhibit A.) EXHIBIT A Forms 1099 and 1098 This is important tax information and is being furnished to the Internal Revenue Service 1099-Div Dividends & Distributions Entity Description General Dynamics Amount Gross qualified dividends $300 1099-Int Interest Entity Description ew Jersey Economic Development bonds N IBM bonds State of Nebraska bonds Amount Gross interest Gross interest Gross interest $300 700 700 1098-Mortgage Interest Statement Entity Description Sunbelt Credit Union Northeast Bank Mortgage interest Home-equity loan interest Amount $7,100 435 Grubstake Mining & Development: preliminary report (preliminary K-1) to Paige for the 2017 tax year: Distribution to shareholder Ordinary income (1% of $200,000) $1,000 2,000 Appendix C 10 In addition to the investments discussed above, Paige owns 1,000 shares of Grubstake Mining & Development common stock Grubstake is organized as an S corporation and has 100,000 shares outstanding (S corp ID number 45-4567890) Grubstake reported taxable income of $200,000 and paid a distribution of $1.00 per share during the current year Paige tells you that Grubstake typically does not send out its K-1 reports until late April However, its preliminary report has been consistent with the K-1 for many years (See Exhibit A.) Paige does not materially participate in Grubstake’s activities 11 Paige slipped on a wet spot in front of a computer store last July She broke her ankle and was unable to work for two weeks She incurred $1,300 in medical costs, all of which were paid by the owner of the store The store also gave her $1,000 for pain and suffering resulting from the injury ASCI continued to pay her salary during the two weeks she missed because of the accident ASCI’s plan also paid her $1,200 in disability pay for the time she was unable to work Under this plan ASCI pays the premiums for the disability insurance as a taxable fringe benefit 12 Paige received a Form 1099-B from her broker for the sale of the following securities during 2017 The adjusted basis amounts were reported to the IRS Security Nebraska state bonds Cassill Corp (500 shares) Sales Purchase Sales Commission Her Date Date Price Paid on Sale Basis 03/14/17 10/20/17 10/22/11 $2,300 $160 $1,890 02/19/16 8,500 425 9,760 13 In addition to the taxes withheld from her salary, Paige also made timely estimated federal tax payments of $175 per quarter and timely estimated state income tax payments of $150 for the first three quarters The $150 fourth-quarter state payment was made on December 28, 2017 Paige would like to receive a refund for any overpayment 14 Because of her busy work schedule, Paige was unable to provide her accountant with the tax documents necessary for filing her 2016 state and federal income tax returns by the due date (April 15, 2017) In filing her extension on April 15, 2017 she made a federal tax payment of $750 Her return was eventually filed on June 25, 2017 In August 2017, she received a federal refund of $180 and a state tax refund of $60 Her itemized deductions for 2016 were $12,430 15 Paige found a renter for her father’s house on August The monthly rent is $400, and the lease agreement is for one year The lease requires the tenant to pay the first and last months’ rent and a $400 security deposit The security deposit is to be returned at the end of the lease if the property is in good condition On August 1, Paige received $1,200 from the tenant per the terms of the lease agreement In November, the plumbing froze and several pipes burst The tenant had the repairs made and paid the $300 bill In December, he reduced his rental payment to $100 to compensate for the plumbing repairs Paige provides you with the following additional information for the rental in 2017: Property taxes Other maintenance expenses Insurance expense Management fee Depreciation (to be computed) $770 285 495 350 ? The rental property is located at 35 Harvest Street, Orono, Maine 04473 Local practice is to allocate 12 percent of the fair market value of the property to the land (See item #8.) Paige makes all decisions with respect to the property C-11 C-12 Appendix C 16 Paige paid $2,050 in real estate taxes on her principal residence The real estate tax is used to pay for town schools and other municipal services 17 Paige drives a 2015 Acura TL Her car registration fee (based on the car year) is $50 and covers the period 1/1/17 through 12/31/17 In addition, she paid $280 in property tax to the state based on the book value of the car 18 In addition to the medical costs presented in item #11, Paige incurred the following unreimbursed medical costs: Dentist Doctor Prescription drugs Over-the-counter drugs Optometrist Emergency room charges LASIK eye surgery Chiropractor $ 310 390 215 140 125 440 2,000 265 19 On March 1, Paige took advantage of low interest rates and refinanced her $75,000 home mortgage with her original lender. Paige purchased the home in 2015 The new home loan is for 15 years She paid $215 in closing costs and $1,500 in discount points (prepaid interest) to obtain the loan The house is worth $155,000 and Paige’s basis in the house is $90,000 As part of the refinancing arrangement, she also obtained a $10,000 home-equity loan She used the proceeds from the homeequity loan to reduce the balance due on her credit cards Paige received several Form 1098 statements from her bank for interest paid by her in 2017 Details appear below (See also Exhibit A on page C-11.) Primary home mortgage Home-equity loan Credit cards Car loan $7,100 435 498 390 20 On May 14, 2017, Paige contributed clothing to the Salvation Army The original cost of the clothing was $740 She has substantiation valuing the donation at $360 The Salvation Army is located at 350 Stone Ridge Road, Bangor, Maine 04401 In addition, she made the following cash contributions and received a statement from each of the following organizations acknowledging her contribution: Larkin College United Way First Methodist Church Amos House (homeless shelter) Local Chamber of Commerce $850 125 790 200 100 21 Paige sells real estate in the evening and on weekends (considered an active trade or business) She runs her business from a rental office she shares with several other realtors (692 River Road, Bangor, Maine 04401) The name of her business is Turner Real Estate and the federal identification number is 05-8799561 Her business code is 531210 Paige has been operating in a business-like way since 2006 and has always shown a profit She had the following income and expenses from her business: Commissions earned Expenses: Advertising Telephone Real estate license Rent Utilities $21,250 2,200 95 130 6,000 600 ... Manager; and Sue Culbertson, Senior Buyer xx Changes in Taxation of Individuals and Business Entities, 2019 Edition For the 2019 edition of McGraw- Hill’s Taxation of Individuals and Business Entities, ... University McGRAW- HILL’S TAXATION OF INDIVIDUALS AND BUSINESS ENTITIES, 2019 EDITION, TENTH EDITION Published by McGraw- Hill Education, Penn Plaza, New York, NY 10121 Copyright © 2019 by McGraw- Hill... Transfer Taxes and Wealth Planning McGraw- Hill’s Essentials of Federal Taxation is designed for a one-semester course, covering the basics of taxation of individuals and business entities To facilitate