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CHAPTER 3 TAX DETERMINATION; PERSONAL AND DEPENDENCY EXEMPTIONS; AN OVERVIEW OF PROPERTY TRANSACTIONS SOLUTIONS TO PROBLEM MATERIALS
3-1
3-4
2006 Comprehensive Volume/Solutions
DISCUSSION QUESTIONS 1.
b. i. h. d. c. f. g. a.
Income (broadly conceived) Exclusions Gross income Deductions for AGI Adjusted gross income The greater of the standard deduction or itemized deductions Personal and dependency exemptions Taxable income
Otherwise stated: b. – i. = h. – d. = c. – f. – g. = a. The child tax credit (choice e.) is subtracted from any income tax liability to arrive at the tax due (or refund). p. 3-2 and Figure 3-1 2.
Borrowing money has no tax effect as it must be repaid. Collecting a loan that was made (presuming no interest is involved) and the recovery of a rent deposit are return of capital situations. A loss on the sale of a personal asset has no tax effect. p. 3-3 and Examples 1 and 39
3.
a., b., and f. are exclusions, while items c., d., and e. are inclusions. Rewards (item d.) are payments for services rendered and are compensatory in nature. Although a gift is an exclusion, item e. is not a gift but a payment for a service performed. Exhibits 3-1 and 3-2
4.
b., d., and f. are inclusions, while items a., c., and e. are exclusions. Item f. is designated as an “honorarium,” but it is not an excludable gift. It is, instead, a payment for services rendered. Exhibits 3-1 and 3-2
5.
Double taxation will occur if the country where the services are performed imposes an income tax. The compensation income earned in the foreign country also is subject to U.S. tax, due to the application of the global (or worldwide) tax approach. U.S. tax law, however, does mitigate the double tax result by allowing an exclusion for foreign earned income and/or a credit for foreign taxes paid. Global Tax Issues, p. 3–5
6.
a.
Yes. It reduces AGI, and this allows a larger casualty loss deduction. Casualty losses must exceed 10% of AGI.
b.
Yes, it ceases to be relevant. Personal casualty losses are deductions from AGI, and the standard deduction is in lieu of such deductions.
pp. 3-5, 3-6, Examples 3 and 4 and Exhibit 3-3 7.
The Andersons are expecting more than they will receive. To take advantage of the medical deduction, taxpayers must itemize. By itemizing, the standard deduction (including the additional standard deduction for age 65 or older) cannot be claimed. Thus, the Andersons can claim a tax benefit from either their medical expenses or their age but not from both. pp. 3-7 and 3-8
8.
a.
No personal exemption is allowed a dependent on his or her tax return.
b.
$800 is one of two choices as a standard deduction. The other is earned income + $250.
Tax Determination; Exemptions; Overview of Property Transactions
3-5
c.
Both are taxed, but earned income may help determine the standard deduction selected.
d.
Additional standard deductions for age and blindness (if appropriate) are allowed a dependent.
pp. 3-9, 3-10, and Examples 9 and 11 9.
a.
The person being claimed under a multiple support agreement must otherwise qualify as a dependent. Thus, the gross income, relationship, absence of a joint return, and citizenship tests must also be satisfied.
b.
A person cannot be awarded the dependency exemption unless his or her contribution is more than 10%.
c.
Form 2120 must be completed by the parties waiving the exemption and included with the return of the person claiming the exemption.
pp. 3-12, 3-13, and Example 16 10.
a.
No. Does not meet the adobe test.
b.
Yes. Meets all tests. A niece is a descendant of a brother or sister.
c.
Yes. Meets all tests. Need not meet the age test due to disability.
d.
Yes. Meets all tests. A nephew is a descendant of a brother or sister. Due to student status, meets the age test.
e.
No. A son-in-law does not meet the relationship test.
f.
No. A cousin does not meet the relationship test.
p. 3-15 11.
a.
Under the qualifying relative test, the scope of the relationship test is broader. Also included are taxpayer’s ascendants (e.g., parents, grandparents), siblings and their children, uncles and aunts, step-parents and step-siblings, certain in-laws, and members of the taxpayer’s household.
b.
The gross income test is not relevant to the qualifying child definition. (Note: the AGI of eligible claimants may be considered in tie-breaker situations.)
c.
The joint return test applies to both categories.
d.
Except when the child is self-supporting, the support test does not affect the definition of a qualifying child.
e.
In the case of a qualifying child, the age test is “under 19 or under 24 and a fulltime student.” The qualifying relative category carries no age requirements.
f.
The domicile test must be met in the case of a qualifying child. It needs to be satisfied under the qualifying relative category only if the individual has to be treated as a member of the taxpayer’s household.
3-6
2006 Comprehensive Volume/Solutions p. 3-16 and Concept Summary 3-1
12.
a.
Adriana and Hector qualify for 2005.
b.
Adriana, Hector, and Carrie.
c.
An ex-spouse cannot be claimed as a dependent in the year of the divorce.
d.
If their relationship was in violation of state law.
pp. 3-13, 3-14, and Footnote 14 13.
Roberto should definitely encourage his parents and aunts to move to Mexico. As residents of Mexico, they will now qualify as dependents. Needless to say, being able to claim four additional dependency exemptions is bound to help Roberto’s income tax situation. p. 3-14
14.
a.
Stealth taxes are not separate taxes. On a phase-out basis (predicated on increasing income), they operate to deny higher bracket taxpayers various tax benefits available to others. They avoid the need for Congress to enact new taxes to raise revenue.
b.
The Tax Relief Reconciliation Act of 2001 provides for the elimination of two of these stealth taxes—phase-out of personal and dependency exemptions and of certain itemized deductions. Unfortunately, the phase-out does not begin until 2006 and is not complete until 2010. The Jobs and Growth Tax Relief Reconciliation Act of 2003 accelerated some of the 2001 Act provisions.
See the Tax in the News on p. 3-18. 15.
a.
The rates were 15%, 28%, 31%, 36%, and 39.6%.
b.
Over a phase-in period from 2001 to 2006, the rates would become 10%, 15%, 25%, 28%, 33%, and 35%.
c.
JGTRRA accelerated the phase-in to 2003.
d.
After 2010, pre-2001 rates are to be restored.
e.
Adam Smith’s canon of certainty this is not!
pp. 3-19, 3-21, and Tax in the News on p. 3-21 16.
a.
For the kiddie tax to apply, the child must not have reached age 14 by the close of the taxable year.
b.
The kiddie tax does not apply unless unearned income is more than $1,600.
c.
If a child under age 14 is required to file a return, a parent may elect to report the unearned income in excess of $1,600 on his (or her) own return if the following conditions are met:
Tax Determination; Exemptions; Overview of Property Transactions
3-7
•
Gross income is from interest and dividends only.
•
Gross income is more than $800 but less than $8,000.
•
No estimated tax has been paid in the name and Social Security number of the child, and the child is not subject to backup withholding.
If this parental election is made, the child is not required to file a tax return. pp. 3-22 to 3-24 17.
a.
In 2005, a single individual who is age 65 or over and blind would have a filing requirement of $9,450 ($5,000 standard deduction + $1,250 additional standard deduction for age + $3,200 personal exemption). The additional standard deduction for blindness is not considered in computing the filing level.
b.
The standard deduction, the additional standard deduction for being age 65 or over, and the personal exemption are taken into consideration in determining the filing requirements, but the additional standard deduction for blindness is not considered.
pp. 3-24, 3-25, and Tables 3-1, 3-2, and 3-4 18.
For 2005, Ginger can file either a joint return or as married filing separately. The former filing status is preferable, but this depends on whether the executor of her husband’s estate agrees. Ginger does not qualify as a surviving spouse for 2006 and 2007, because she does not have a dependent “child” as a member of her household. She would, however, qualify for head of household filing status. p. 3-30 and Example 36
19.
a.
Head of household filing status is available since only one parent needs to qualify as a dependent.
b.
Head of household filing status is available since the son is a dependent under the qualifying child category.
c.
Head of household filing status is not available. Due to the age test, the son is not a qualifying child. Due to the gross income test, the son does not satisfy the requirements of a qualifying relative.
d.
Head of household filing status is not available. The daughter is not a member of taxpayer’s household.
pp. 3-30 and 3-31 20.
a.
Head of household filing status is not available. For tax years prior to 2005, the result would be different because an unmarried son did not have to be a dependent. This rule was changed by the Working Families Tax Relief Act of 2004.
b.
Head of household filing status is not available.
c.
Head of household filing status is available.
3-8
2006 Comprehensive Volume/Solutions d.
In c., Florence qualifies as a surviving spouse. She does not in a. and b. because Derrick is not her dependent.
p. 3-30 and Examples 35 to 37 21.
If Fran maintains a household for a dependent child, she probably qualifies as an abandoned spouse. If so, Fran can file as a head of household. pp. 3-30 and 3-31
22.
The loss on the RV is not deductible, while the gain on the sailboat is taxable. Both gains (i.e., sailboat and land) are capital. Whether they are short- or long-term depends on the holding period (more than one year for long-term capital gains). pp. 3-32, 3-33, and Example 39
23.
Kaitlyn’s stamp collection is a “collectible,” and the former rate of 28% was not changed by JGTRRA of 2003. a.
$4,200 (28% X $15,000).
b.
$2,250 (15% X $15,000).
p. 3-33 24.
Of the loss, $3,000 ($2,000 short-term and $1,000 long-term) is deducted against ordinary income with the short-term loss being used first. The remaining $1,000 of longterm capital loss is carried over to 2006 as a long-term capital loss. p. 3-34 and Example 44
25.
Collectibles include art, antiques, gems, metals, stamps, some coins and bullion, and alcoholic beverages which are held as investments. a.
If held for more than one year, collectibles are taxed at a maximum rate of 28%. If the taxpayer’s marginal tax rate is lower, the lower rate applies.
b.
The beneficial treatment under the alternative tax applies only if the holding period is greater than one year. If held for one year or less, they are taxed at the taxpayer’s regular tax rate.
pp. 3-33, 3-34, and Example 43 26.
a.
If the parties live in Indiana, Marcie can use head of household filing status. Her household includes a related dependent, Audry. The joint return test does not disqualify Audry because the purpose of the filing is to recover amounts withheld. Due to the age test, Jamie does not meet the definition of a qualifying child. Furthermore, he does not satisfy the requirement of a qualifying relative in view of the gross income test.
b.
If the parties live in California, Jamie’s earnings become $1,750 (50% X $3,500). Since this is less than the exemption amount of $3,200, Jamie passes the gross income test and can be claimed by Marcie as a dependent. Although Audry now has gross income of $1,750, this does not disqualify her from her status as a dependent. Like part a. above, Marcie can use head of household filing status.
pp. 3-14, 3-36, and Examples 47 and 48
Tax Determination; Exemptions; Overview of Property Transactions 27.
3-9
Under a multiple support agreement, Erica should claim her mother as a dependent. As part of the contribution toward support, Erica should pay for any medical expenses her mother incurs. With her children and because her brothers do not itemize, Erica is the party most likely to obtain a tax benefit from her mother’s medical expenses. However, if Erica receives no benefit from a medical expense deduction (due to 7.5% of AGI limit), then the dependency exemption should be rotated and the medical expenses divided accordingly. p. 3-36 and Example 49
PROBLEMS 28.
a.
AGI Less: Standard deduction Personal and dependency exemptions (4 X $3,200) Taxable income
$55,000 (10,000) (12,800) $32,200
b.
AGI Less: Standard deduction Additional standard deduction (Kay) Personal and dependency exemptions (3 X $3,200) Taxable income
$70,000 (7,300) (1,250) (9,600) $51,850
c.
AGI Less: Itemized deductions Personal and dependency exemptions (3 X $3,200) Taxable income
$81,000 (7,900) (9,600) $63,500
d.
AGI Less: Standard deduction Personal and dependency exemptions (5 X $3,200) Taxable income
$48,000 (10,000) (16,000) $22,000
e.
AGI Less: Standard deduction Personal and dependency exemptions (2 X $3,200) Taxable income
$54,000 (7,300) (6,400) $40,300
pp. 3-5 to 3-8 and Table 3-1 and 3-2 29.
Salary Interest on GMC bonds Alimony Capital loss IRA contribution Office pool AGI Standard deduction Personal and dependency exemptions (3 X $3,200) Taxable income
$40,000 1,200 (2,400) (3,000) (4,000) 3,200 $35,000 (7,300) (9,600) $18,100
The child support payments are nondeductible. The gift is a nontaxable exclusion. Only $3,000 of the capital loss is deductible—the balance of $1,000 is carried over to 2006. pp. 3-5 to 3-8, 3-34, Figure 3-1, Exhibits 3-1 and 3-2, and Table 3-1
3-10 30.
2006 Comprehensive Volume/Solutions Salary Prize AGI Itemized deductions ($4,800 + $3,600) Personal and dependency exemptions (4 X $3,200) Taxable income
$70,000 5,000 $75,000 (8,400) (12,800) $53,800
The $2,000 of interest on the Chicago bonds, the insurance proceeds of $50,000, and the $90,000 of damages for personal injuries are all exclusions. Itemized deductions ($8,400) were claimed as they exceeded the standard deduction ($7,300). pp. 3-6 to 3-8, Figure 3-1, and Exhibits 3-1 to 3-3 31.
a.
$5,000. Although $4,800 (earned income) + $250 = $5,050, the amount allowed cannot exceed that available in 2005 for single taxpayers.
b.
$3,550. $3,300 (earned income) + $250.
c.
$800. The greater of $800 or $400 (earned income) + $250.
d.
$850. The greater of $800 or $600 (earned income) + $250.
e.
$3,300. $1,800 (earned income) + $250 + $1,250 (additional standard deduction).
pp. 3-9, 3-10, Tables 3-1 and 3-2, and Examples 8 to 11 32.
a.
Four. Two personal and two dependency exemptions. Elton is a qualifying child, so his gross income does not matter. Amanda is not a qualifying child—although a full-time student, she is not under age 24. However, Amanda fits under the qualifying relative category. She passes the gross income test because the tuition portion of a scholarship is nontaxable.
b.
Two. One personal and one dependency exemption. Regardless of the year of divorce, Clint cannot qualify as he is not a member of Audry’s household. Olive meets the relationship test.
c.
Two. One personal and one dependency exemption. As a daughter, Carin is a qualifying child. Pierce, who is not a qualifying child, cannot come under the qualifying relative category due to the gross income test. (Note: the joint return test appears inapplicable in this case.)
d.
Three. One personal and two dependency exemptions. Pierce’s income is now $2,000 (50% X $4,000), and he satisfies the gross income test of less than $3,200.
pp. 3-10 to 3-17 33.
a.
Three. The parents qualify as dependents under the Mexico/Canada exception.
b.
Two. Pablo’s father does not qualify. Pablo’s mother qualifies since she is a resident of the U.S.
c.
Three. The parents qualify since they are U.S. citizens.
p. 3-14
Tax Determination; Exemptions; Overview of Property Transactions 34.
3-11
a.
Three. Only the niece is a qualifying child as a descendant of a sibling. The cousin is not, due to the relationship test, while the son does not meet the age test. Both the cousin and the son come within the qualifying relative category—the cousin as a member of taxpayer’s household.
b.
Two. Both persons come within the qualifying relative category. The stepmother meets the relationship test, while the family friend’s son is a member of taxpayer’s household.
c.
One. Helena is a qualifying child under the exception to the citizenship or residency test. She lives with her adoption father who is a U.S. citizen.
d.
Three. All come under the qualifying relative category, and it has been assumed that each meets the gross income test. The mother- and brother-in-law satisfy the relationship test, while the ex-husband is a member of the household. The brother-in-law’s age and student status have no bearing on the dependency issue.
pp. 3-15 and 3-17 35.
a.
Tommy is a qualifying child as to all three parties. Therefore, the mother, uncle, and grandfather are eligible to claim him as a dependent.
b.
In this tie-breaker situation, the mother (as parent) will take preference. If the mother forgoes the exemption, the uncle is next in order of preference, due to a higher AGI.
p. 3-15 36.
a.
Two. As a cousin, Ann is not a qualifying child. Under the qualifying relative category, Ann fails the gross income test. In this regard, her age and student status make no difference.
b.
Two. Since Kurt is a qualifying child, the gross income test does not apply.
c.
Three. The parents need not live with Trent as they meet the relationship test. Though not stated, it is assumed that the gross income test is satisfied.
d.
Two. An ex-spouse cannot be a dependent in the year of divorce. The former mother-in-law meets the relationship test.
pp. 3-15 to 3-17 37.
Exemption amount (9 X $3,200) $28,800 Step 1: AGI $230,000 Phase-out threshold (218,950) Excess amount $ 11,050 Step 2: $11,050 ÷ $2,500 = 5 (rounded up) X 2 = 10% (phase-out percentage) Step 3: Less: $28,800 X 10% (2,880) Step 4: Deduction for personal and dependency exemptions $25,920 p. 3-17
3-12 38.
2006 Comprehensive Volume/Solutions Salaries ($46,000 + $51,000) Interest income Contributions to traditional IRAs Adjusted gross income Less: Itemized deductions Personal exemptions (2 X $3,200) Dependency exemptions (3 X $3,200) Taxable income
$11,500 6,400 9,600
$97,000 2,100 (8,000) $91,100 (27,500) $63,600
The $900 of interest on San Francisco bonds and the $24,000 gift from Keri’s parents are exclusions. The $16,000 loss on the sale of the RV is a personal loss and nondeductible. Demi and Kevin fall under the qualifying child rule so the gross income test does not apply. Consequently, each can be claimed as a dependent. Homer passes the gross income test because at that income level Social Security benefits are exclusions. pp. 3-4 to 3-8, 3-15, 3-16, Example 39, Exhibits 3-1 and 3-2, and Figure 3-1 39.
a.
Wages Bank interest Bond interest (City of Chicago bond interest is tax-exempt) Gross income Less: Standard deduction* Personal exemption** Taxable income
$2,100 1,150 -0$3,250 (2,350) (-0-) $ 900
b.
Bank interest Bond interest Total unearned income Minus: $800 + $800 standard deduction Income taxed at parents’ rate
$1,150 -0$1,150 (1,600) $ -0-
Income taxed at Bob’s rate
$ 900
Total tax ($900 X 10%)***
$
90
*A dependent’s standard deduction is limited to the greater of $800 or the sum of his or her earned income plus $250. **A dependent may not claim a personal exemption on his or her return. ***Since Bob’s unearned income is not more than $1,600, his tax is determined without using his parents’ rate. Thus, Bob’s 2005 tax liability is $90 ($900 taxable income X 10%). pp. 3-9, 3-10, 3-22 to 3-24, Exhibits 3-1 and 3-2, and Example 10. 40.
a.
Regardless of where the parties reside, it is essential that the damage of the joint return be undone. The joint return test applies to both the qualifying child and qualifying relative categories of dependency exemptions. The situation can be rectified by filing separate returns on or before April 17, 2006 (April 15 falls on a Saturday). In Louisiana, one-half of the daughter’s income, or $5,500 (50% X $11,000), is assigned to John. Being a qualifying child, the daughter can be claimed as a dependent. John, however, is subject to the gross income test
Tax Determination; Exemptions; Overview of Property Transactions
3-13
contained in the qualifying relative category. Since $5,500 exceeds $3,200, 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 the daughter’s income is earned by John. Consequently, John now meets the gross income test of a qualifying relative. The daughter also can be claimed as a dependent since there is no gross income test applicable to the qualifying child category.
Examples 45, 47, and 48 41.
If Don kept the duplex, the annual tax thereon would generate an income tax liability of $3,300 (33% of $10,000). If Don transfers title to the duplex to Sam, the income tax consequences would be as follows: (1)
Sam would be limited to an $800 standard deduction and would have taxable income of $9,200 ($10,000 – $800 standard deduction), which would be taxed at his own rate because he is not under 14 years of age.
(2)
Sam would pay $1,015 tax on the $9,200 taxable income [($7,300 X 10%) + ($1,900 X 15%)].
The tax saving to the family unit in 2005 if Don transfers the duplex would be $2,285 ($3,300 – $1,015), assuming Sam had no other income or expenses. In addition, the phase-out of Don’s exemptions would be reduced. However, there are other tax consequences to be considered. If the state in which the family resides imposes a state income tax, a further tax saving might result from the transfer. Another consideration is the possibility of Federal and state gift taxes that the transfer might generate. pp. 3-9 and 3-17 42.
a.
Gross income Short-term capital loss Cash prize AGI Less: Personal and dependency exemptions (6 X $3,200) Standard deduction Taxable income
$70,000 (3,000) 2,000 $69,000 (19,200) (10,000) $39,800
Tax on $39,800 using surviving spouse rate schedule: $1,460 + 15%($39,800 – $14,600) = $5,240 Hector’s father does not fail the gross income text because tax-exempt income is not counted. The unused capital loss of $1,000 is carried over to the following year. b.
Gross income Contribution to traditional IRA AGI Less: Personal and dependency exemptions (4 X $3,200) Itemized deductions Taxable income
$80,000 (4,000) $76,000 (12,800) (8,000) $55,200
3-14
2006 Comprehensive Volume/Solutions Tax on $55,200 using head of household rate schedule: 25%($55,200 – $39,800) = $9,298
$5,447.50 +
Although Rosalyn does not meet the relationship test, she is a member of Penny’s household. Jerold and Flo meet the relationship test. Jerold is not a U.S. citizen or resident but is a resident of Canada. pp. 3-7, 3-8, 3-10, 3-14, 3-16, 3-30, 3-34, Figure 3-1, and Table 3-1 43.
Unearned income Minus: $800 base amount + $800 standard deduction Unearned income taxed at parents’ rate
$1,800 (1,600) $ 200
Ginni’s parents are in the 25% bracket, so her unearned income would generate $50 of tax (25% X $200). Computation of Ginni’s taxable income and tax: Earned income Interest income Gross income Less: Personal exemption Less: Standard deduction [greater of $800 or $2,100 (earned income) + $250] Taxable income Less: Unearned income taxed at parents’ rate Income taxed at Ginni’s rate Ginni’s tax rate Tax at Ginni’s rate
$2,100 1,800 $3,900 -0(2,350) $1,550 (200) $1,350 X 10% $ 135
Ginni’s total tax: $50 (unearned income taxed at parents’ rate) + $135 (taxed at Ginni’s rate) = $185. pp. 3-22 to 3-24 and Example 32 44.
Unearned income (interest) Base amount not taxed at parents’ rate Standard deduction Unearned income taxed at parents’ rate
$11,100 (800) (800) $ 9,500
Nash’s parents cannot make the parental election. pp. 3-22 to 3-24 and Example 32 45.
a.
Sam and Lana must file since their gross income of $18,500 is more than the $18,400 filing requirement.
b.
Bobby is not required to file. Although he can be claimed as a dependent on his parents’ return, his earned income and gross income is less than $5,000 (his standard deduction).
c.
Mike is not required to file since his gross income of $9,200 is less than the $9,450 filing requirement.
d.
Marge is required to file. Her gross income is less than $8,200, but her net earnings from self-employment are more than $400.
Tax Determination; Exemptions; Overview of Property Transactions
3-15
Taxpayers in a. and b. should file, even if a return is not required, to obtain a refund if any income tax was withheld. p. 3-24 and Table 3-4 46.
a.
Ben must file a tax return. He is claimed on his parents’ return. He has earned income only, but gross income of more than the standard deduction of $5,000.
b.
Anita must file a tax return since she is claimed on her parents’ return and has unearned income greater than $800. Anita’s unearned income is less than the amount required to trigger a tax at her parents’ rate. Furthermore, her parents cannot make the parental election because Anita’s unearned income is not over $1,600.
c.
Earl must file a tax return since he is claimed on his parents’ return and has both earned plus unearned income and gross income of more than the larger of $800 or the sum of earned income plus $250.
d.
Karen is not required to file a tax return. Her gross income of $3,800 ($2,600 wages + $1,200 interest) is less than her filing requirement of $4,100 [$2,850 (the greater of $800 or the sum of earned income + $250) + $1,250 (additional standard deduction for being blind)].
e.
Pat must file a tax return since she has net self-employment earnings of $400 or more.
p. 3-25 47.
a.
Bianca should file a joint return—she can sign for her late husband as executor of his estate.
b.
Bianca does not qualify for surviving spouse filing status due to not meeting the “child” requirement. She does, however, qualify for head of household status.
c.
Now, Bianca qualifies for surviving spouse status. “Child” includes a stepchild.
d.
Bianca is an abandoned spouse and is regarded as being single. Consequently, she can use head of household filing status.
pp. 3-29, 3-31, and Examples 34 and 36 48.
a.
Prior to 2005, an unmarried child could qualify a taxpayer for head of household filing status even if the child was not a dependent. The Working Families Tax Relief Act of 2004 deleted this exception. For tax years after 2004, the child must be a dependent. Therefore, Winston must use single filing status.
b.
Winston must use single filing status. See answer to part a. above.
c.
Winston qualifies for head of household filing status. As long as one parent is his dependent, this is enough.
d.
Winston must use single filing status. Except in the case of parents, head of household status requires that the dependent be a member of taxpayer’s household.
3-16
2006 Comprehensive Volume/Solutions pp. 3-30, 3-31, and Examples 33 and 34
49.
a.
For year 2003, Jerold can use married filing jointly status. Because he is executor of the estate, he can make the election to file jointly on Nadia’s behalf. In this regard, whether Macy qualifies as a dependent child makes no difference. Moreover, under the former rules applicable prior to 2005, Macy is a dependent within the gross income exception for a child under 19 years of age.
b.
For 2004, Jerold can use head of household filing status. Under prior rules, an unmarried child did not have to be a dependent for head of household purposes. Because Macy now is age 19, she no longer comes within the gross income exception and, therefore, is not Jerold’s dependent.
c.
For 2005, Jerold qualifies as a surviving spouse. Macy is a dependent under the qualifying child rule. Her gross income is immaterial under this rule, but her student status raises the age limitation to 24.
pp. 3-14 to 3-16, 3-30, and Examples 34 and 37 50.
a.
For year 2004, Rosalyn should file a joint return. Because she is the executor of the estate, she can issue the consent on behalf of Miles. Rosalyn can claim two personal (hers and Miles) and two dependency exemptions. Sue is a child and is exempt from the gross income test by being under 19 years of age. Peyton meets the relationship test and satisfies the gross income test. Example 34 For year 2005, Rosalyn should file as a head of household. She is not a surviving spouse because Sue is not her dependent. Sue is not a qualifying child due to the age limitation, and she is not a qualifying relative due to the gross income test. Peyton meets the qualifying relative test. Thus, Rosalyn can claim one personal and one dependency exemption. Example 36
b.
For year 2004, Rosalyn should file a joint return (see part a. above). Rosalyn can claim two personal and one dependency exemption. Sue qualifies as a dependent due to the child exception (for under age 19) to the gross income test, while Peyton does not. Peyton is not a child, and the $4,000 (50% of $8,000) he earns disqualifies him under the gross income test. For year 2005, Rosalyn should file as a single taxpayer. She can claim one personal and no dependency exemptions. Sue is not a qualifying child due to the age limitations and is not a qualifying relative due to the gross income test. Peyton is not a qualifying relative due to the gross income test—he earns $4,000 (50% of $8,000), which is more than $3,200. Example 48
(Note: In both parts a. and b., it has been assumed that Peyton and Sue do not file a joint return.) pp. 3-13 to 3-17 and 3-30 51.
a.
$2,410. The tax on the LTCG from the sale of the city lot is $450 ($3,000 X 15%). The STCG of $8,000 from the sale of the fishing cabin is offset by the STCL of $1,000 from the sale of the GMC stock for a net result of a STCG of $7,000. The tax on the $7,000 is $1,960 ($7,000 X 28%). Therefore, the total tax is $2,410 ($450 + $1,960). The garage sale produces a nondeductible personal loss.
Tax Determination; Exemptions; Overview of Property Transactions b.
3-17
$1,200. The tax on the LTCG becomes $150 ($3,000 X 5%), and the tax on the STCG becomes $1,050 ($7,000 X 15%) for a total of $1,200 ($150 + $1,050).
pp. 3-33 and 3-34 52.
a.
$580. The STCL of $2,000 from the sale of the GE stock is applied against the $3,000 gain from the coin collection, leaving a net collectible gain of $1,000. The tax on this gain is $280 ($1,000 X 28%). To this is added $300 ($2,000 X 15%), which is the tax on the LTCG from the sale of the land, for a total of $580 ($280 + $300).
b.
$250. The tax on the net collectible gain becomes $150 ($1,000 X 15%), and the tax on the LTCG becomes $100 ($2,000 X 5%) for a total of $250 ($150 + $100).
Example 43 53.
If Amelia does nothing, her taxes for both years would be as follows: AGI Less: Personal exemption Standard deduction Taxable income
2005 $60,000 (3,200) (5,000) $51,800
2006 $61,000 (3,200) (5,000) $52,800
The income tax for 2005 is $9,615 [$4,090 + 25%($51,800 – $29,700)] and for 2006 is $9,865 [$4,090 + 25%($52,800 – $29,700)] for a total of $19,480 ($9,615 + $9,865). If Amelia prepays her church pledge, her taxes for both years would be as follows: AGI Less: Personal exemption Itemized deductions ($1,300 + $1,100 + $4,800) Standard deduction Taxable income
2005 $60,000 (3,200)
2006 $61,000 (3,200)
(7,200) -0$49,600
-0(5,000) $52,800
The income tax for 2005 is $9,065 [$4,090 + 25%($49,600 – $29,700)] and for 2006 is $9,865 [$4,900 + 25%($52,800 – $29,700)] for a combined total of $18,930 ($9,065 + $9,865). Consequently, Amelia’s prepayment of her church pledge in 2005 saves her $550 ($19,480 – $18,930) in income taxes. p. 3-34 CUMULATIVE PROBLEMS 54.
Gross income ($48,000 + $49,000) (Note 1) Interest income (Note 2)— CD at Wells Fargo Bank Money Market account at Sparks State Bank
$97,000 $600 400
1,000
3-18
2006 Comprehensive Volume/Solutions Cash dividend from SBC stock (Note 3) Property transactions (Note 4)— Houseboat gain (Note 5) $2,500 Land loss (Note 6) (4,000) AGI Itemized deductions ($6,600 + $5,100 + $1,800 + $2,400 + $0) (Note 7) Personal exemptions (2 X $3,200) Dependency exemptions (3 X $3,200) (Note 8) Taxable income Tax on taxable income (married filing jointly) (Note 9) Less: Withholdings Net tax payable (or refund due) for 2005
3,200 (1,500) $99,700 (15,900) (6,400) (9,600) $67,800 $ 9,960 (12,200) ($ 2,240)
Notes (1)
The gift of $22,000, the bequest of $160,000, and the life insurance proceeds of $50,000 are exclusions from gross income.
(2)
The interest of $300 from municipal bonds is an exclusion.
(3)
Although qualified dividends are subject to tax at a preferential rate, they are included in full as part of gross income.
(4)
The garage sale results in a nondeductible personal loss of $7,200.
(5)
Although losses are not deductible, gains from the sale of personal use assets are subject to tax.
(6)
Only excess capital losses are subject to an annual $3,000 limit on deductibility. Capital losses always are fully deductible when applied against capital gains.
(7)
Medical expenses of $3,100 do not exceed 7.5% of AGI ($99,700 X .075 = $7,478).
(8)
Cole and Henry meet the definition of qualifying child, while Robyn does not. Cole is under age 19, and Henry, as a full-time student, is under age 24. Robyn does not meet either age test. Also, Robyn cannot fall under the qualifying relative category due to the gross income test. Faye is a dependent because she is a qualifying relative.
(9)
Tax on $3,200 ($3,200 X 15%)* = Tax on $64,600 ($67,800 – $3,200): On $59,400 = $5,200 X 25% = *Special rate applicable to qualified dividends.
$ 480 8,180 1,300 $9,960
Tax Determination; Exemptions; Overview of Property Transactions 55.
3-19
Part I. Tax Computation Salary Interest income ($5,700 + $6,300) Less alimony payments ($300 X 11 payments) AGI Less: Standard deduction (Note 1) Personal and dependency exemptions ($3,100 X 2) Taxable income Tax on taxable income (see Tax Tables) head of household Less amounts withheld of $10,900 Net tax payable (or refund due) for 2004
$62,000 12,000 (3,300) $70,700 (7,150) (6,200) $57,350 $ 9,944 (10,900) ($ 956)
Note 1: The standard deduction of $7,150 for a head of household is greater than the itemized deductions of $6,400 ($3,300 + $1,200 + $1,300 + $600). See the tax return solution beginning on page 3-21 of the Solutions Manual. Part II. Tax Planning Willis, Hoffman, Maloney, and Raabe, CPAs 5191 Natorp Boulevard Mason, OH 45040 February 25, 2005 Mr. Horace Fern 321 Grant Avenue Cheyenne, WY 82002 Dear Horace: I am enclosing your completed tax return for 2004. Please sign on page 2 of Form 1040 and use the enclosed envelope for mailing the return to the IRS by April 15, 2005. Regarding your tax position for 2005, the death of your mother causes you to lose a dependency exemption for her. Also, you will no longer qualify for head of household filing status. Instead, you must use the less favorable tax rates applicable to single taxpayers. You also will lose a deduction for alimony payments. The salary increase causes more income to be taxed. A quick summation of the changes is as follows: 2004 taxable income Taxable income for 2005 will increase because of: Increase in income for 2005 (salary) Decrease in deductions: Exemption for mother claimed in 2004 Alimony paid to ex-wife Itemized deductions of $6,400 in 2005 (standard deduction of $5,000 is less) versus standard deduction in 2004 of $7,150 Taxable income for 2005 will decrease because of: Increase in exemption amount for 2005 Projected taxable income for 2005
$57,350 6,200 3,100 3,300 750 (100) $70,600
3-20
2006 Comprehensive Volume/Solutions Tax on projected 2005 taxable income using tax rate schedule applicable to single taxpayers: $4,090 + 25%($70,600 – $29,700) Less: 2004 tax Increase in tax
$14,315 (9,944) $ 4,371
One investment decision you should reappraise are the CDs you hold. Although they appear to be yielding a return of around 3%, the interest is fully taxed at a rate of 25% or potentially 28%. Investments in stock, on the other hand, now carry two important advantages. First, dividends are taxed at a top rate of 15%. Second, long-term (more than a year) gain, if any, also is taxed at a top rate of 15%. If I can be of further assistance to you, please call me. Sincerely, Jane Welsch, CPA Partner Enclosure
Tax Determination; Exemptions; Overview of Property Transactions 55.
3-21
3-22 55. continued
2006 Comprehensive Volume/Solutions
Tax Determination; Exemptions; Overview of Property Transactions 55. continued
3-23
3-1
3-4
2006 Comprehensive Volume/Solutions
DISCUSSION QUESTIONS 1.
b. i. h. d. c. f. g. a.
Income (broadly conceived) Exclusions Gross income Deductions for AGI Adjusted gross income The greater of the standard deduction or itemized deductions Personal and dependency exemptions Taxable income
Otherwise stated: b. – i. = h. – d. = c. – f. – g. = a. The child tax credit (choice e.) is subtracted from any income tax liability to arrive at the tax due (or refund). p. 3-2 and Figure 3-1 2.
Borrowing money has no tax effect as it must be repaid. Collecting a loan that was made (presuming no interest is involved) and the recovery of a rent deposit are return of capital situations. A loss on the sale of a personal asset has no tax effect. p. 3-3 and Examples 1 and 39
3.
a., b., and f. are exclusions, while items c., d., and e. are inclusions. Rewards (item d.) are payments for services rendered and are compensatory in nature. Although a gift is an exclusion, item e. is not a gift but a payment for a service performed. Exhibits 3-1 and 3-2
4.
b., d., and f. are inclusions, while items a., c., and e. are exclusions. Item f. is designated as an “honorarium,” but it is not an excludable gift. It is, instead, a payment for services rendered. Exhibits 3-1 and 3-2
5.
Double taxation will occur if the country where the services are performed imposes an income tax. The compensation income earned in the foreign country also is subject to U.S. tax, due to the application of the global (or worldwide) tax approach. U.S. tax law, however, does mitigate the double tax result by allowing an exclusion for foreign earned income and/or a credit for foreign taxes paid. Global Tax Issues, p. 3–5
6.
a.
Yes. It reduces AGI, and this allows a larger casualty loss deduction. Casualty losses must exceed 10% of AGI.
b.
Yes, it ceases to be relevant. Personal casualty losses are deductions from AGI, and the standard deduction is in lieu of such deductions.
pp. 3-5, 3-6, Examples 3 and 4 and Exhibit 3-3 7.
The Andersons are expecting more than they will receive. To take advantage of the medical deduction, taxpayers must itemize. By itemizing, the standard deduction (including the additional standard deduction for age 65 or older) cannot be claimed. Thus, the Andersons can claim a tax benefit from either their medical expenses or their age but not from both. pp. 3-7 and 3-8
8.
a.
No personal exemption is allowed a dependent on his or her tax return.
b.
$800 is one of two choices as a standard deduction. The other is earned income + $250.
Tax Determination; Exemptions; Overview of Property Transactions
3-5
c.
Both are taxed, but earned income may help determine the standard deduction selected.
d.
Additional standard deductions for age and blindness (if appropriate) are allowed a dependent.
pp. 3-9, 3-10, and Examples 9 and 11 9.
a.
The person being claimed under a multiple support agreement must otherwise qualify as a dependent. Thus, the gross income, relationship, absence of a joint return, and citizenship tests must also be satisfied.
b.
A person cannot be awarded the dependency exemption unless his or her contribution is more than 10%.
c.
Form 2120 must be completed by the parties waiving the exemption and included with the return of the person claiming the exemption.
pp. 3-12, 3-13, and Example 16 10.
a.
No. Does not meet the adobe test.
b.
Yes. Meets all tests. A niece is a descendant of a brother or sister.
c.
Yes. Meets all tests. Need not meet the age test due to disability.
d.
Yes. Meets all tests. A nephew is a descendant of a brother or sister. Due to student status, meets the age test.
e.
No. A son-in-law does not meet the relationship test.
f.
No. A cousin does not meet the relationship test.
p. 3-15 11.
a.
Under the qualifying relative test, the scope of the relationship test is broader. Also included are taxpayer’s ascendants (e.g., parents, grandparents), siblings and their children, uncles and aunts, step-parents and step-siblings, certain in-laws, and members of the taxpayer’s household.
b.
The gross income test is not relevant to the qualifying child definition. (Note: the AGI of eligible claimants may be considered in tie-breaker situations.)
c.
The joint return test applies to both categories.
d.
Except when the child is self-supporting, the support test does not affect the definition of a qualifying child.
e.
In the case of a qualifying child, the age test is “under 19 or under 24 and a fulltime student.” The qualifying relative category carries no age requirements.
f.
The domicile test must be met in the case of a qualifying child. It needs to be satisfied under the qualifying relative category only if the individual has to be treated as a member of the taxpayer’s household.
3-6
2006 Comprehensive Volume/Solutions p. 3-16 and Concept Summary 3-1
12.
a.
Adriana and Hector qualify for 2005.
b.
Adriana, Hector, and Carrie.
c.
An ex-spouse cannot be claimed as a dependent in the year of the divorce.
d.
If their relationship was in violation of state law.
pp. 3-13, 3-14, and Footnote 14 13.
Roberto should definitely encourage his parents and aunts to move to Mexico. As residents of Mexico, they will now qualify as dependents. Needless to say, being able to claim four additional dependency exemptions is bound to help Roberto’s income tax situation. p. 3-14
14.
a.
Stealth taxes are not separate taxes. On a phase-out basis (predicated on increasing income), they operate to deny higher bracket taxpayers various tax benefits available to others. They avoid the need for Congress to enact new taxes to raise revenue.
b.
The Tax Relief Reconciliation Act of 2001 provides for the elimination of two of these stealth taxes—phase-out of personal and dependency exemptions and of certain itemized deductions. Unfortunately, the phase-out does not begin until 2006 and is not complete until 2010. The Jobs and Growth Tax Relief Reconciliation Act of 2003 accelerated some of the 2001 Act provisions.
See the Tax in the News on p. 3-18. 15.
a.
The rates were 15%, 28%, 31%, 36%, and 39.6%.
b.
Over a phase-in period from 2001 to 2006, the rates would become 10%, 15%, 25%, 28%, 33%, and 35%.
c.
JGTRRA accelerated the phase-in to 2003.
d.
After 2010, pre-2001 rates are to be restored.
e.
Adam Smith’s canon of certainty this is not!
pp. 3-19, 3-21, and Tax in the News on p. 3-21 16.
a.
For the kiddie tax to apply, the child must not have reached age 14 by the close of the taxable year.
b.
The kiddie tax does not apply unless unearned income is more than $1,600.
c.
If a child under age 14 is required to file a return, a parent may elect to report the unearned income in excess of $1,600 on his (or her) own return if the following conditions are met:
Tax Determination; Exemptions; Overview of Property Transactions
3-7
•
Gross income is from interest and dividends only.
•
Gross income is more than $800 but less than $8,000.
•
No estimated tax has been paid in the name and Social Security number of the child, and the child is not subject to backup withholding.
If this parental election is made, the child is not required to file a tax return. pp. 3-22 to 3-24 17.
a.
In 2005, a single individual who is age 65 or over and blind would have a filing requirement of $9,450 ($5,000 standard deduction + $1,250 additional standard deduction for age + $3,200 personal exemption). The additional standard deduction for blindness is not considered in computing the filing level.
b.
The standard deduction, the additional standard deduction for being age 65 or over, and the personal exemption are taken into consideration in determining the filing requirements, but the additional standard deduction for blindness is not considered.
pp. 3-24, 3-25, and Tables 3-1, 3-2, and 3-4 18.
For 2005, Ginger can file either a joint return or as married filing separately. The former filing status is preferable, but this depends on whether the executor of her husband’s estate agrees. Ginger does not qualify as a surviving spouse for 2006 and 2007, because she does not have a dependent “child” as a member of her household. She would, however, qualify for head of household filing status. p. 3-30 and Example 36
19.
a.
Head of household filing status is available since only one parent needs to qualify as a dependent.
b.
Head of household filing status is available since the son is a dependent under the qualifying child category.
c.
Head of household filing status is not available. Due to the age test, the son is not a qualifying child. Due to the gross income test, the son does not satisfy the requirements of a qualifying relative.
d.
Head of household filing status is not available. The daughter is not a member of taxpayer’s household.
pp. 3-30 and 3-31 20.
a.
Head of household filing status is not available. For tax years prior to 2005, the result would be different because an unmarried son did not have to be a dependent. This rule was changed by the Working Families Tax Relief Act of 2004.
b.
Head of household filing status is not available.
c.
Head of household filing status is available.
3-8
2006 Comprehensive Volume/Solutions d.
In c., Florence qualifies as a surviving spouse. She does not in a. and b. because Derrick is not her dependent.
p. 3-30 and Examples 35 to 37 21.
If Fran maintains a household for a dependent child, she probably qualifies as an abandoned spouse. If so, Fran can file as a head of household. pp. 3-30 and 3-31
22.
The loss on the RV is not deductible, while the gain on the sailboat is taxable. Both gains (i.e., sailboat and land) are capital. Whether they are short- or long-term depends on the holding period (more than one year for long-term capital gains). pp. 3-32, 3-33, and Example 39
23.
Kaitlyn’s stamp collection is a “collectible,” and the former rate of 28% was not changed by JGTRRA of 2003. a.
$4,200 (28% X $15,000).
b.
$2,250 (15% X $15,000).
p. 3-33 24.
Of the loss, $3,000 ($2,000 short-term and $1,000 long-term) is deducted against ordinary income with the short-term loss being used first. The remaining $1,000 of longterm capital loss is carried over to 2006 as a long-term capital loss. p. 3-34 and Example 44
25.
Collectibles include art, antiques, gems, metals, stamps, some coins and bullion, and alcoholic beverages which are held as investments. a.
If held for more than one year, collectibles are taxed at a maximum rate of 28%. If the taxpayer’s marginal tax rate is lower, the lower rate applies.
b.
The beneficial treatment under the alternative tax applies only if the holding period is greater than one year. If held for one year or less, they are taxed at the taxpayer’s regular tax rate.
pp. 3-33, 3-34, and Example 43 26.
a.
If the parties live in Indiana, Marcie can use head of household filing status. Her household includes a related dependent, Audry. The joint return test does not disqualify Audry because the purpose of the filing is to recover amounts withheld. Due to the age test, Jamie does not meet the definition of a qualifying child. Furthermore, he does not satisfy the requirement of a qualifying relative in view of the gross income test.
b.
If the parties live in California, Jamie’s earnings become $1,750 (50% X $3,500). Since this is less than the exemption amount of $3,200, Jamie passes the gross income test and can be claimed by Marcie as a dependent. Although Audry now has gross income of $1,750, this does not disqualify her from her status as a dependent. Like part a. above, Marcie can use head of household filing status.
pp. 3-14, 3-36, and Examples 47 and 48
Tax Determination; Exemptions; Overview of Property Transactions 27.
3-9
Under a multiple support agreement, Erica should claim her mother as a dependent. As part of the contribution toward support, Erica should pay for any medical expenses her mother incurs. With her children and because her brothers do not itemize, Erica is the party most likely to obtain a tax benefit from her mother’s medical expenses. However, if Erica receives no benefit from a medical expense deduction (due to 7.5% of AGI limit), then the dependency exemption should be rotated and the medical expenses divided accordingly. p. 3-36 and Example 49
PROBLEMS 28.
a.
AGI Less: Standard deduction Personal and dependency exemptions (4 X $3,200) Taxable income
$55,000 (10,000) (12,800) $32,200
b.
AGI Less: Standard deduction Additional standard deduction (Kay) Personal and dependency exemptions (3 X $3,200) Taxable income
$70,000 (7,300) (1,250) (9,600) $51,850
c.
AGI Less: Itemized deductions Personal and dependency exemptions (3 X $3,200) Taxable income
$81,000 (7,900) (9,600) $63,500
d.
AGI Less: Standard deduction Personal and dependency exemptions (5 X $3,200) Taxable income
$48,000 (10,000) (16,000) $22,000
e.
AGI Less: Standard deduction Personal and dependency exemptions (2 X $3,200) Taxable income
$54,000 (7,300) (6,400) $40,300
pp. 3-5 to 3-8 and Table 3-1 and 3-2 29.
Salary Interest on GMC bonds Alimony Capital loss IRA contribution Office pool AGI Standard deduction Personal and dependency exemptions (3 X $3,200) Taxable income
$40,000 1,200 (2,400) (3,000) (4,000) 3,200 $35,000 (7,300) (9,600) $18,100
The child support payments are nondeductible. The gift is a nontaxable exclusion. Only $3,000 of the capital loss is deductible—the balance of $1,000 is carried over to 2006. pp. 3-5 to 3-8, 3-34, Figure 3-1, Exhibits 3-1 and 3-2, and Table 3-1
3-10 30.
2006 Comprehensive Volume/Solutions Salary Prize AGI Itemized deductions ($4,800 + $3,600) Personal and dependency exemptions (4 X $3,200) Taxable income
$70,000 5,000 $75,000 (8,400) (12,800) $53,800
The $2,000 of interest on the Chicago bonds, the insurance proceeds of $50,000, and the $90,000 of damages for personal injuries are all exclusions. Itemized deductions ($8,400) were claimed as they exceeded the standard deduction ($7,300). pp. 3-6 to 3-8, Figure 3-1, and Exhibits 3-1 to 3-3 31.
a.
$5,000. Although $4,800 (earned income) + $250 = $5,050, the amount allowed cannot exceed that available in 2005 for single taxpayers.
b.
$3,550. $3,300 (earned income) + $250.
c.
$800. The greater of $800 or $400 (earned income) + $250.
d.
$850. The greater of $800 or $600 (earned income) + $250.
e.
$3,300. $1,800 (earned income) + $250 + $1,250 (additional standard deduction).
pp. 3-9, 3-10, Tables 3-1 and 3-2, and Examples 8 to 11 32.
a.
Four. Two personal and two dependency exemptions. Elton is a qualifying child, so his gross income does not matter. Amanda is not a qualifying child—although a full-time student, she is not under age 24. However, Amanda fits under the qualifying relative category. She passes the gross income test because the tuition portion of a scholarship is nontaxable.
b.
Two. One personal and one dependency exemption. Regardless of the year of divorce, Clint cannot qualify as he is not a member of Audry’s household. Olive meets the relationship test.
c.
Two. One personal and one dependency exemption. As a daughter, Carin is a qualifying child. Pierce, who is not a qualifying child, cannot come under the qualifying relative category due to the gross income test. (Note: the joint return test appears inapplicable in this case.)
d.
Three. One personal and two dependency exemptions. Pierce’s income is now $2,000 (50% X $4,000), and he satisfies the gross income test of less than $3,200.
pp. 3-10 to 3-17 33.
a.
Three. The parents qualify as dependents under the Mexico/Canada exception.
b.
Two. Pablo’s father does not qualify. Pablo’s mother qualifies since she is a resident of the U.S.
c.
Three. The parents qualify since they are U.S. citizens.
p. 3-14
Tax Determination; Exemptions; Overview of Property Transactions 34.
3-11
a.
Three. Only the niece is a qualifying child as a descendant of a sibling. The cousin is not, due to the relationship test, while the son does not meet the age test. Both the cousin and the son come within the qualifying relative category—the cousin as a member of taxpayer’s household.
b.
Two. Both persons come within the qualifying relative category. The stepmother meets the relationship test, while the family friend’s son is a member of taxpayer’s household.
c.
One. Helena is a qualifying child under the exception to the citizenship or residency test. She lives with her adoption father who is a U.S. citizen.
d.
Three. All come under the qualifying relative category, and it has been assumed that each meets the gross income test. The mother- and brother-in-law satisfy the relationship test, while the ex-husband is a member of the household. The brother-in-law’s age and student status have no bearing on the dependency issue.
pp. 3-15 and 3-17 35.
a.
Tommy is a qualifying child as to all three parties. Therefore, the mother, uncle, and grandfather are eligible to claim him as a dependent.
b.
In this tie-breaker situation, the mother (as parent) will take preference. If the mother forgoes the exemption, the uncle is next in order of preference, due to a higher AGI.
p. 3-15 36.
a.
Two. As a cousin, Ann is not a qualifying child. Under the qualifying relative category, Ann fails the gross income test. In this regard, her age and student status make no difference.
b.
Two. Since Kurt is a qualifying child, the gross income test does not apply.
c.
Three. The parents need not live with Trent as they meet the relationship test. Though not stated, it is assumed that the gross income test is satisfied.
d.
Two. An ex-spouse cannot be a dependent in the year of divorce. The former mother-in-law meets the relationship test.
pp. 3-15 to 3-17 37.
Exemption amount (9 X $3,200) $28,800 Step 1: AGI $230,000 Phase-out threshold (218,950) Excess amount $ 11,050 Step 2: $11,050 ÷ $2,500 = 5 (rounded up) X 2 = 10% (phase-out percentage) Step 3: Less: $28,800 X 10% (2,880) Step 4: Deduction for personal and dependency exemptions $25,920 p. 3-17
3-12 38.
2006 Comprehensive Volume/Solutions Salaries ($46,000 + $51,000) Interest income Contributions to traditional IRAs Adjusted gross income Less: Itemized deductions Personal exemptions (2 X $3,200) Dependency exemptions (3 X $3,200) Taxable income
$11,500 6,400 9,600
$97,000 2,100 (8,000) $91,100 (27,500) $63,600
The $900 of interest on San Francisco bonds and the $24,000 gift from Keri’s parents are exclusions. The $16,000 loss on the sale of the RV is a personal loss and nondeductible. Demi and Kevin fall under the qualifying child rule so the gross income test does not apply. Consequently, each can be claimed as a dependent. Homer passes the gross income test because at that income level Social Security benefits are exclusions. pp. 3-4 to 3-8, 3-15, 3-16, Example 39, Exhibits 3-1 and 3-2, and Figure 3-1 39.
a.
Wages Bank interest Bond interest (City of Chicago bond interest is tax-exempt) Gross income Less: Standard deduction* Personal exemption** Taxable income
$2,100 1,150 -0$3,250 (2,350) (-0-) $ 900
b.
Bank interest Bond interest Total unearned income Minus: $800 + $800 standard deduction Income taxed at parents’ rate
$1,150 -0$1,150 (1,600) $ -0-
Income taxed at Bob’s rate
$ 900
Total tax ($900 X 10%)***
$
90
*A dependent’s standard deduction is limited to the greater of $800 or the sum of his or her earned income plus $250. **A dependent may not claim a personal exemption on his or her return. ***Since Bob’s unearned income is not more than $1,600, his tax is determined without using his parents’ rate. Thus, Bob’s 2005 tax liability is $90 ($900 taxable income X 10%). pp. 3-9, 3-10, 3-22 to 3-24, Exhibits 3-1 and 3-2, and Example 10. 40.
a.
Regardless of where the parties reside, it is essential that the damage of the joint return be undone. The joint return test applies to both the qualifying child and qualifying relative categories of dependency exemptions. The situation can be rectified by filing separate returns on or before April 17, 2006 (April 15 falls on a Saturday). In Louisiana, one-half of the daughter’s income, or $5,500 (50% X $11,000), is assigned to John. Being a qualifying child, the daughter can be claimed as a dependent. John, however, is subject to the gross income test
Tax Determination; Exemptions; Overview of Property Transactions
3-13
contained in the qualifying relative category. Since $5,500 exceeds $3,200, 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 the daughter’s income is earned by John. Consequently, John now meets the gross income test of a qualifying relative. The daughter also can be claimed as a dependent since there is no gross income test applicable to the qualifying child category.
Examples 45, 47, and 48 41.
If Don kept the duplex, the annual tax thereon would generate an income tax liability of $3,300 (33% of $10,000). If Don transfers title to the duplex to Sam, the income tax consequences would be as follows: (1)
Sam would be limited to an $800 standard deduction and would have taxable income of $9,200 ($10,000 – $800 standard deduction), which would be taxed at his own rate because he is not under 14 years of age.
(2)
Sam would pay $1,015 tax on the $9,200 taxable income [($7,300 X 10%) + ($1,900 X 15%)].
The tax saving to the family unit in 2005 if Don transfers the duplex would be $2,285 ($3,300 – $1,015), assuming Sam had no other income or expenses. In addition, the phase-out of Don’s exemptions would be reduced. However, there are other tax consequences to be considered. If the state in which the family resides imposes a state income tax, a further tax saving might result from the transfer. Another consideration is the possibility of Federal and state gift taxes that the transfer might generate. pp. 3-9 and 3-17 42.
a.
Gross income Short-term capital loss Cash prize AGI Less: Personal and dependency exemptions (6 X $3,200) Standard deduction Taxable income
$70,000 (3,000) 2,000 $69,000 (19,200) (10,000) $39,800
Tax on $39,800 using surviving spouse rate schedule: $1,460 + 15%($39,800 – $14,600) = $5,240 Hector’s father does not fail the gross income text because tax-exempt income is not counted. The unused capital loss of $1,000 is carried over to the following year. b.
Gross income Contribution to traditional IRA AGI Less: Personal and dependency exemptions (4 X $3,200) Itemized deductions Taxable income
$80,000 (4,000) $76,000 (12,800) (8,000) $55,200
3-14
2006 Comprehensive Volume/Solutions Tax on $55,200 using head of household rate schedule: 25%($55,200 – $39,800) = $9,298
$5,447.50 +
Although Rosalyn does not meet the relationship test, she is a member of Penny’s household. Jerold and Flo meet the relationship test. Jerold is not a U.S. citizen or resident but is a resident of Canada. pp. 3-7, 3-8, 3-10, 3-14, 3-16, 3-30, 3-34, Figure 3-1, and Table 3-1 43.
Unearned income Minus: $800 base amount + $800 standard deduction Unearned income taxed at parents’ rate
$1,800 (1,600) $ 200
Ginni’s parents are in the 25% bracket, so her unearned income would generate $50 of tax (25% X $200). Computation of Ginni’s taxable income and tax: Earned income Interest income Gross income Less: Personal exemption Less: Standard deduction [greater of $800 or $2,100 (earned income) + $250] Taxable income Less: Unearned income taxed at parents’ rate Income taxed at Ginni’s rate Ginni’s tax rate Tax at Ginni’s rate
$2,100 1,800 $3,900 -0(2,350) $1,550 (200) $1,350 X 10% $ 135
Ginni’s total tax: $50 (unearned income taxed at parents’ rate) + $135 (taxed at Ginni’s rate) = $185. pp. 3-22 to 3-24 and Example 32 44.
Unearned income (interest) Base amount not taxed at parents’ rate Standard deduction Unearned income taxed at parents’ rate
$11,100 (800) (800) $ 9,500
Nash’s parents cannot make the parental election. pp. 3-22 to 3-24 and Example 32 45.
a.
Sam and Lana must file since their gross income of $18,500 is more than the $18,400 filing requirement.
b.
Bobby is not required to file. Although he can be claimed as a dependent on his parents’ return, his earned income and gross income is less than $5,000 (his standard deduction).
c.
Mike is not required to file since his gross income of $9,200 is less than the $9,450 filing requirement.
d.
Marge is required to file. Her gross income is less than $8,200, but her net earnings from self-employment are more than $400.
Tax Determination; Exemptions; Overview of Property Transactions
3-15
Taxpayers in a. and b. should file, even if a return is not required, to obtain a refund if any income tax was withheld. p. 3-24 and Table 3-4 46.
a.
Ben must file a tax return. He is claimed on his parents’ return. He has earned income only, but gross income of more than the standard deduction of $5,000.
b.
Anita must file a tax return since she is claimed on her parents’ return and has unearned income greater than $800. Anita’s unearned income is less than the amount required to trigger a tax at her parents’ rate. Furthermore, her parents cannot make the parental election because Anita’s unearned income is not over $1,600.
c.
Earl must file a tax return since he is claimed on his parents’ return and has both earned plus unearned income and gross income of more than the larger of $800 or the sum of earned income plus $250.
d.
Karen is not required to file a tax return. Her gross income of $3,800 ($2,600 wages + $1,200 interest) is less than her filing requirement of $4,100 [$2,850 (the greater of $800 or the sum of earned income + $250) + $1,250 (additional standard deduction for being blind)].
e.
Pat must file a tax return since she has net self-employment earnings of $400 or more.
p. 3-25 47.
a.
Bianca should file a joint return—she can sign for her late husband as executor of his estate.
b.
Bianca does not qualify for surviving spouse filing status due to not meeting the “child” requirement. She does, however, qualify for head of household status.
c.
Now, Bianca qualifies for surviving spouse status. “Child” includes a stepchild.
d.
Bianca is an abandoned spouse and is regarded as being single. Consequently, she can use head of household filing status.
pp. 3-29, 3-31, and Examples 34 and 36 48.
a.
Prior to 2005, an unmarried child could qualify a taxpayer for head of household filing status even if the child was not a dependent. The Working Families Tax Relief Act of 2004 deleted this exception. For tax years after 2004, the child must be a dependent. Therefore, Winston must use single filing status.
b.
Winston must use single filing status. See answer to part a. above.
c.
Winston qualifies for head of household filing status. As long as one parent is his dependent, this is enough.
d.
Winston must use single filing status. Except in the case of parents, head of household status requires that the dependent be a member of taxpayer’s household.
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2006 Comprehensive Volume/Solutions pp. 3-30, 3-31, and Examples 33 and 34
49.
a.
For year 2003, Jerold can use married filing jointly status. Because he is executor of the estate, he can make the election to file jointly on Nadia’s behalf. In this regard, whether Macy qualifies as a dependent child makes no difference. Moreover, under the former rules applicable prior to 2005, Macy is a dependent within the gross income exception for a child under 19 years of age.
b.
For 2004, Jerold can use head of household filing status. Under prior rules, an unmarried child did not have to be a dependent for head of household purposes. Because Macy now is age 19, she no longer comes within the gross income exception and, therefore, is not Jerold’s dependent.
c.
For 2005, Jerold qualifies as a surviving spouse. Macy is a dependent under the qualifying child rule. Her gross income is immaterial under this rule, but her student status raises the age limitation to 24.
pp. 3-14 to 3-16, 3-30, and Examples 34 and 37 50.
a.
For year 2004, Rosalyn should file a joint return. Because she is the executor of the estate, she can issue the consent on behalf of Miles. Rosalyn can claim two personal (hers and Miles) and two dependency exemptions. Sue is a child and is exempt from the gross income test by being under 19 years of age. Peyton meets the relationship test and satisfies the gross income test. Example 34 For year 2005, Rosalyn should file as a head of household. She is not a surviving spouse because Sue is not her dependent. Sue is not a qualifying child due to the age limitation, and she is not a qualifying relative due to the gross income test. Peyton meets the qualifying relative test. Thus, Rosalyn can claim one personal and one dependency exemption. Example 36
b.
For year 2004, Rosalyn should file a joint return (see part a. above). Rosalyn can claim two personal and one dependency exemption. Sue qualifies as a dependent due to the child exception (for under age 19) to the gross income test, while Peyton does not. Peyton is not a child, and the $4,000 (50% of $8,000) he earns disqualifies him under the gross income test. For year 2005, Rosalyn should file as a single taxpayer. She can claim one personal and no dependency exemptions. Sue is not a qualifying child due to the age limitations and is not a qualifying relative due to the gross income test. Peyton is not a qualifying relative due to the gross income test—he earns $4,000 (50% of $8,000), which is more than $3,200. Example 48
(Note: In both parts a. and b., it has been assumed that Peyton and Sue do not file a joint return.) pp. 3-13 to 3-17 and 3-30 51.
a.
$2,410. The tax on the LTCG from the sale of the city lot is $450 ($3,000 X 15%). The STCG of $8,000 from the sale of the fishing cabin is offset by the STCL of $1,000 from the sale of the GMC stock for a net result of a STCG of $7,000. The tax on the $7,000 is $1,960 ($7,000 X 28%). Therefore, the total tax is $2,410 ($450 + $1,960). The garage sale produces a nondeductible personal loss.
Tax Determination; Exemptions; Overview of Property Transactions b.
3-17
$1,200. The tax on the LTCG becomes $150 ($3,000 X 5%), and the tax on the STCG becomes $1,050 ($7,000 X 15%) for a total of $1,200 ($150 + $1,050).
pp. 3-33 and 3-34 52.
a.
$580. The STCL of $2,000 from the sale of the GE stock is applied against the $3,000 gain from the coin collection, leaving a net collectible gain of $1,000. The tax on this gain is $280 ($1,000 X 28%). To this is added $300 ($2,000 X 15%), which is the tax on the LTCG from the sale of the land, for a total of $580 ($280 + $300).
b.
$250. The tax on the net collectible gain becomes $150 ($1,000 X 15%), and the tax on the LTCG becomes $100 ($2,000 X 5%) for a total of $250 ($150 + $100).
Example 43 53.
If Amelia does nothing, her taxes for both years would be as follows: AGI Less: Personal exemption Standard deduction Taxable income
2005 $60,000 (3,200) (5,000) $51,800
2006 $61,000 (3,200) (5,000) $52,800
The income tax for 2005 is $9,615 [$4,090 + 25%($51,800 – $29,700)] and for 2006 is $9,865 [$4,090 + 25%($52,800 – $29,700)] for a total of $19,480 ($9,615 + $9,865). If Amelia prepays her church pledge, her taxes for both years would be as follows: AGI Less: Personal exemption Itemized deductions ($1,300 + $1,100 + $4,800) Standard deduction Taxable income
2005 $60,000 (3,200)
2006 $61,000 (3,200)
(7,200) -0$49,600
-0(5,000) $52,800
The income tax for 2005 is $9,065 [$4,090 + 25%($49,600 – $29,700)] and for 2006 is $9,865 [$4,900 + 25%($52,800 – $29,700)] for a combined total of $18,930 ($9,065 + $9,865). Consequently, Amelia’s prepayment of her church pledge in 2005 saves her $550 ($19,480 – $18,930) in income taxes. p. 3-34 CUMULATIVE PROBLEMS 54.
Gross income ($48,000 + $49,000) (Note 1) Interest income (Note 2)— CD at Wells Fargo Bank Money Market account at Sparks State Bank
$97,000 $600 400
1,000
3-18
2006 Comprehensive Volume/Solutions Cash dividend from SBC stock (Note 3) Property transactions (Note 4)— Houseboat gain (Note 5) $2,500 Land loss (Note 6) (4,000) AGI Itemized deductions ($6,600 + $5,100 + $1,800 + $2,400 + $0) (Note 7) Personal exemptions (2 X $3,200) Dependency exemptions (3 X $3,200) (Note 8) Taxable income Tax on taxable income (married filing jointly) (Note 9) Less: Withholdings Net tax payable (or refund due) for 2005
3,200 (1,500) $99,700 (15,900) (6,400) (9,600) $67,800 $ 9,960 (12,200) ($ 2,240)
Notes (1)
The gift of $22,000, the bequest of $160,000, and the life insurance proceeds of $50,000 are exclusions from gross income.
(2)
The interest of $300 from municipal bonds is an exclusion.
(3)
Although qualified dividends are subject to tax at a preferential rate, they are included in full as part of gross income.
(4)
The garage sale results in a nondeductible personal loss of $7,200.
(5)
Although losses are not deductible, gains from the sale of personal use assets are subject to tax.
(6)
Only excess capital losses are subject to an annual $3,000 limit on deductibility. Capital losses always are fully deductible when applied against capital gains.
(7)
Medical expenses of $3,100 do not exceed 7.5% of AGI ($99,700 X .075 = $7,478).
(8)
Cole and Henry meet the definition of qualifying child, while Robyn does not. Cole is under age 19, and Henry, as a full-time student, is under age 24. Robyn does not meet either age test. Also, Robyn cannot fall under the qualifying relative category due to the gross income test. Faye is a dependent because she is a qualifying relative.
(9)
Tax on $3,200 ($3,200 X 15%)* = Tax on $64,600 ($67,800 – $3,200): On $59,400 = $5,200 X 25% = *Special rate applicable to qualified dividends.
$ 480 8,180 1,300 $9,960
Tax Determination; Exemptions; Overview of Property Transactions 55.
3-19
Part I. Tax Computation Salary Interest income ($5,700 + $6,300) Less alimony payments ($300 X 11 payments) AGI Less: Standard deduction (Note 1) Personal and dependency exemptions ($3,100 X 2) Taxable income Tax on taxable income (see Tax Tables) head of household Less amounts withheld of $10,900 Net tax payable (or refund due) for 2004
$62,000 12,000 (3,300) $70,700 (7,150) (6,200) $57,350 $ 9,944 (10,900) ($ 956)
Note 1: The standard deduction of $7,150 for a head of household is greater than the itemized deductions of $6,400 ($3,300 + $1,200 + $1,300 + $600). See the tax return solution beginning on page 3-21 of the Solutions Manual. Part II. Tax Planning Willis, Hoffman, Maloney, and Raabe, CPAs 5191 Natorp Boulevard Mason, OH 45040 February 25, 2005 Mr. Horace Fern 321 Grant Avenue Cheyenne, WY 82002 Dear Horace: I am enclosing your completed tax return for 2004. Please sign on page 2 of Form 1040 and use the enclosed envelope for mailing the return to the IRS by April 15, 2005. Regarding your tax position for 2005, the death of your mother causes you to lose a dependency exemption for her. Also, you will no longer qualify for head of household filing status. Instead, you must use the less favorable tax rates applicable to single taxpayers. You also will lose a deduction for alimony payments. The salary increase causes more income to be taxed. A quick summation of the changes is as follows: 2004 taxable income Taxable income for 2005 will increase because of: Increase in income for 2005 (salary) Decrease in deductions: Exemption for mother claimed in 2004 Alimony paid to ex-wife Itemized deductions of $6,400 in 2005 (standard deduction of $5,000 is less) versus standard deduction in 2004 of $7,150 Taxable income for 2005 will decrease because of: Increase in exemption amount for 2005 Projected taxable income for 2005
$57,350 6,200 3,100 3,300 750 (100) $70,600
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2006 Comprehensive Volume/Solutions Tax on projected 2005 taxable income using tax rate schedule applicable to single taxpayers: $4,090 + 25%($70,600 – $29,700) Less: 2004 tax Increase in tax
$14,315 (9,944) $ 4,371
One investment decision you should reappraise are the CDs you hold. Although they appear to be yielding a return of around 3%, the interest is fully taxed at a rate of 25% or potentially 28%. Investments in stock, on the other hand, now carry two important advantages. First, dividends are taxed at a top rate of 15%. Second, long-term (more than a year) gain, if any, also is taxed at a top rate of 15%. If I can be of further assistance to you, please call me. Sincerely, Jane Welsch, CPA Partner Enclosure
Tax Determination; Exemptions; Overview of Property Transactions 55.
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3-22 55. continued
2006 Comprehensive Volume/Solutions
Tax Determination; Exemptions; Overview of Property Transactions 55. continued
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