CHAPTER 3



CHAPTER 3

TAX DETERMINATION; PERSONAL AND DEPENDENCY EXEMPTIONS;

AN OVERVIEW OF PROPERTY TRANSACTIONS

SOLUTIONS TO PROBLEM MATERIALS

| | | | |Status: | | Q/P |

|Question/ | | | |Present | | in Prior |

|Problem | |Topic | |Edition | |Edition |

| | | | | | |

|1 | |Tax formula | |New | |

|2 | |Transactions with no income tax effect | |New | |

|3 | |Gross income: exclusions | |Unchanged |3 |

|4 | |Gross income: inclusions | |Unchanged |4 |

|5 | |Income tax: international considerations | |Unchanged |5 |

|6 | |Effect of AGI on some deductions from | |New | |

|7 | |Issue ID | |Unchanged |7 |

|8 | |Dependents and the determination of their standard deduction and personal| |New | |

| | |exemptions | | | |

|9 | |Dependency exemption: treatment of scholarships for the support and gross | |Unchanged |9 |

| | |income tests | | | |

|10 | |Dependency exemption: multiple support agreement |Unchanged |10 |

|11 | |Dependency exemption: gross income and relationship tests | |Unchanged |11 |

|12 | |Issue ID | |Unchanged |12 |

|13 | |Issue ID | |Unchanged |13 |

|14 | |Stealth taxes | |Unchanged |14 |

|15 | |Income tax rates: background and instability | |New | |

|16 | |Characteristics of the kiddie tax | |Unchanged |15 |

|17 | |Filing requirement | |Modified |16 |

|18 | |Marriage penalty | |New | |

|19 | |Surviving spouse status | |Unchanged |19 |

|20 | |Filing status | |Unchanged |20 |

|21 | |Issue ID | |Unchanged |21 |

|22 | |Treatment of capital gains | |Unchanged |22 |

|23 | |Treatment of capital gains | |New | |

|24 | |Capital loss tax treatment | |Unchanged |24 |

| | | | | | |

|25 | |Capital transactions: treatment of collectibles | |Unchanged |25 |

|26 | |Issue ID | |Unchanged |26 |

|27 | |Multiple support agreement: planning for | |Unchanged |27 |

|* 28 | |Taxable income calculation | |New | |

|* 29 | |Taxable income calculation | |Unchanged |29 |

|* 30 | |Taxable income calculation | |Unchanged |30 |

|31 | |Standard deduction of dependent | |Modified |31 |

|32 | |Personal and dependency exemptions | |New | |

|33 | |Personal and dependency exemptions | |Unchanged |33 |

|34 | |Personal and dependency exemptions | |Modified |34 |

|* 35 | |Exemption deduction determination: phaseout | |New | |

|* 36 | |Determine taxable income | |Unchanged |36 |

|* 37 | |Unearned income of child under age 14 | |Modified |37 |

|38 | |Dependency exemptions: joint return test | |Unchanged |38 |

|39 | |Dependent’s tax liability: unearned income | |Unchanged |39 |

|* 40 | |Tax liability calculations | |New | |

|* 41 | |Taxable income calculation | |Unchanged |41 |

|* 42 | |Child’s income taxed at parents’ rate | |Unchanged |42 |

|* 43 | |Child’s income taxed at parents’ rate | |Unchanged |43 |

|* 44 | |Marriage penalty | |New | |

|45 | |Filing requirements | |Modified |45 |

|46 | |Filing requirements | |Unchanged |46 |

|47 | |Filing status determination | |Unchanged |47 |

|48 | |Filing status determination | |Unchanged |48 |

|49 | |Filing status determination | |Unchanged |49 |

|50 | |Filing status determination; dependency exemptions |Unchanged |50 |

|* 51 | |Capital transactions: determination of tax | |New | |

|* 52 | |Capital transactions: determination of tax | |New | |

|53 | |Tax planning: alternating years for itemized deductions with standard | |New | |

| | |deduction | | | |

|* 54 | |Cumulative | |New | |

|* 55 | |Cumulative | |Unchanged |55 |

| | | | | | | |

|Research | | | | | | |

|Problem | | | | | | |

| | | | | | |

|1 | |Divorced parents with equal custody of children; no waiver | |New | |

|2 | |Joint return and innocent spouse relief | |Unchanged | |

|3 | |Internet activity | |Unchanged | |

*The solution to this problem is available on a transparency master.

CHECK FIGURES

28.a. $46,600.

28.b. $37,900.

28.c. $27,350.

28.d. $22,350.

29. $19,550.

30. $54,200.

31.a. $4,850.

31.b. $3,450.

31.c. $800.

31.d. $850.

31.e. $3,250.

32.a. Three.

32.b. Four.

32.c. Three.

32.d. Two.

33.a. Three.

33.b. Two.

33.c. Three.

34.a. Four.

34.b. Two.

34.c. Three.

34.d. Three.

34.e. Two.

35. $25,420.

36. $67,100.

37.a. $900.

37.b. $90.

39. Transferring the duplex saves $2,277.

40.a. $5,390.

40.b. $9,963.

40.c. $13,400.

41. $11,750.

42. Taxable income $1,550; tax $185.

43. $9,500.

44. Filing separately yields same result

as filing jointly.

45.a. Sam and Lana need not file.

45.b. Bobby is not required to file.

45.c. Mike is required to file.

45.d. Marge must file.

46.a. Ben must file.

46.b. Anita must file.

46.c. Earl must file.

46.d. Karen is not required to file.

46.e. Pat must file.

47.a. Joint return.

47.b. Head of household.

47.c. Surviving spouse.

47.d. Head of household.

48.a. Head of household.

48.b. Single.

48.c. Head of household.

48.d. Single.

49. 2002 married filing joint; 2003 surviving spouse; 2004 head of household.

50. Head of household; one.

51.a. $3,180.

51.b. $1,400.

52.a. $1,460.

52.b. $600.

53. Yes; saves $587.

54. Taxable income $70,900.

55. Refund due $799.

DISCUSSION QUESTIONS

1. b. Income (broadly conceived)

i. Exclusions

h. Gross income

d. Deductions for AGI

c. Adjusted gross income

f. The greater of the standard deduction or itemized deductions

g. Personal and dependency exemptions

a. 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 35

3. b. and d. are exclusions. a., c., e., and f. are inclusions. p. 3-3, Example 2, and Exhibits 3-1 and 3-2

4. b., e., and f. are inclusions. a., c., and d. are exclusions. Although b. is described as a “gift,” it is obviously a “bribe.” pp. 3-3, 3-5, and Exhibits 3-1 and 3-2

5. The biggest difference would be the elimination of various provisions in the tax law that mitigate the effect of double taxation. Thus, there would be no need for the foreign tax credit, as foreign source income would be subject only to foreign taxes. It would not be subject to U.S. tax, as it would not be from a U.S. source. See Global Tax Issues on 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. This may not be the case. Since the Masons will become 65 years old, the standard deduction amount will increase and this alternative may prove more beneficial than itemizing (dfrom). pp. 3-6 to 3-8 and Tables 3-1 and 3-2

8. a. No personal exemption is allowed a dependent.

b. $800 is one of two choices as a standard deduction. The other is earned income + $250.

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. A scholarship received by a student is not included for purposes of computing whether the taxpayer furnished more than half of the student’s support. p. 3-11 and Example 13

b. For purposes of satisfying the gross income test, the nontaxable portion of a scholarship is not considered, but the taxable (i.e., included in gross income) portion is. p. 3-14

10. 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. 3-11, 3-12, and Example 17

11. As to the cousins, only the one who lives with Nelda qualifies. Cousins do not satisfy the relationship test; so they must qualify as members of the taxpayer’s household. Nieces meet the relationship test; so the niece qualifies. p. 3-13

12. a. Adriana and Hector qualify for 2004.

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.

p. 3-13 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. 3-16.

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. 3-17, 3-18, and Tax in the News on p. 3-18

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

d. For children of divorced parents, the taxable income of the custodial parent is used to determine the allocable parental tax.

pp. 3-20 to 3-22

17. a. In 2004, a single individual who is age 65 or over and blind would have a filing requirement of $9,150 ($4,850 standard deduction + $1,200 additional standard deduction for age + $3,100 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. 3-7, 3-8, 3-23, and Tables 3-1, 3-2, and 3-4

18. a. It causes some married couples to pay a larger income tax than if they were single. See the results of Example 30 in the text and compare Example 31.

b. The standard deduction was increased, and the reach of the 15% tax bracket was extended for married persons filing a joint return. p. 3-27

c. Lower-income couples who claim the standard deduction will benefit the most. See Tax in the News on p. 3-27.

19. For 2004, 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 2005 and 2006, 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. 3-28 and Example 32

20. a. Head of household. Example 33

b. Single. p. 3-28

c. Head of household. p. 3-28

d. In c., Florence qualifies as a surviving spouse. This is not so in a. and b. as Derrick is not Florence’s dependent. p. 3-28 and Example 30

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. 3-28 and 3-29

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. 3-29, 3-30, and Example 35

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).

pp. 3-30 and 3-31

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 long-term capital loss is carried over to 2005 as a long-term capital loss. p. 3-31 and Example 40

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. 3-30, 3-31, and Example 39

26. a. If the parties live in New York, Marcie can claim Audry as her dependent. The fact that Audry filed a joint return does not matter when the purpose of the filing is to recover amounts withheld. However, Marcie cannot claim Jamie because he fails the gross income test. But since Marcie can claim Audry, she qualifies for head of household filing status. pp. 3-14 and 3-28

b. If the parties live in Arizona, Marcie can claim both Jamie and Audry. Jamie’s income now becomes $1,750 (50% X $3,500), and he now satisfies the gross income test (not in excess of $3,100). As in part a. above, Marcie qualifies for head of household filing status. p. 3-33 and Example 43

27. 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. 3-33 and Example 44

PROBLEMS

28. a. AGI $70,000

Less: Itemized deduction (11,000)

Personal and dependency exemptions (4 X $3,100) (12,400)

Taxable income $46,600

No additional standard deduction is allowed for a dependent age 65 or over (one of Emily’s parents).

b. AGI $60,000

Less: Standard deduction (9,700)

Personal and dependency exemptions (4 X $3,100) (12,400)

Taxable income $37,900

c. AGI $50,000

Less: Standard deduction (head of household) (7,150)

Personal and dependence exemptions (5 X $3,100) (15,500)

Taxable income $27,350

d. AGI $40,000

Less: Standard deduction (head of household) (7,150)

Additional standard deduction (Abigail) (1,200)

Personal and dependency exemptions (3 X $3,100) (9,300)

Taxable income $22,350

pp. 3-9, 3-10, 3-26 to 3-29, Table 3-1 and 3-2

29. Salary $40,000

Interest on GMC bonds 1,200

Alimony (2,400)

Capital loss (3,000)

IRA contribution (3,000)

Office pool 3,200

AGI $36,000

Standard deduction (7,150)

Personal and dependency exemptions (3 X $3,100) (9,300)

Taxable income $19,550

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 2005.

pp. 3-5 to 3-8, 3-31, Figure 3-1, Exhibits 3-1 and 3-2, and Table 3-1

30. Salary $70,000

Prize 5,000

AGI $75,000

Itemized deductions ($4,800 + $3,600) (8,400)

Personal and dependency exemptions (4 X $3,100) (12,400)

Taxable income $54,200

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 ($7,150).

pp. 3-6, 3-8, Figure 3-1, and Exhibits 3-1 to 3-3

31. a. $4,850. Although $4,800 (earned income) + $250 = $5,050, the amount allowed cannot exceed that available in 2004 for single taxpayers.

b. $3,450. $3,200 (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. $3,250. $1,800 (earned income) + $250 + $1,200 (additional standard deduction).

pp. 3-9, 3-10, Tables 3-1 and 3-2, and Examples 8 to 11

32. a. Three. Ann does not qualify due to the gross income test. Although she is their child who is a full-time student, she is not under age 24.

b. Four. Although Pierce is not a full-time student, he is their child under age 19. Ann now qualifies because she meets the gross income test.

c. Three. As Elton meets the relationship test, he does not have to live with Alice.

d. Two. Trent does not meet the relationship test as does Petula, but he is a member of the household. However, Trent does not pass the gross income test. He does not meet the under-19-years-of-age exception or the student exception, as he is not a “child” of the taxpayer.

pp. 3-10 to 3-14

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

34. a. Four. Two personal exemptions (Miles and Macy) and two dependency exemptions (Macy’s parents). The parents need not live with Miles and Macy as they meet the relationship test.

b. Two. The ex-wife does not meet the relationship test although her brother (Rhett’s ex-brother-in-law) does.

c. Three. The ex-wife now satisfies the member of the household test. The ex-brother-in-law meets the relationship test.

d. Three. One personal exemption and two dependency exemptions. Nephews and nieces meet the relationship test and do not have to live with the taxpayer (although the niece does).

e. Two. One personal exemption and one dependency exemption (the nephew). The niece does not meet the gross income test. The full-time student exception applies only to a child of the taxpayer.

pp. 3-10 to 3-14

35. Exemption amount (10 X $3,100) $31,000

Step 1: AGI $235,000

Phase-out threshold (214,050)

Excess amount $ 20,950

Step 2: $20,950 ÷ $2,500 = 9 (rounded up) X 2 = 18% (phase-out percentage)

Step 3: Less: $31,000 X 18% (5,580)

Step 4: Deduction for personal and dependency exemptions $25,420

p. 3-15

36. Salaries ($46,000 + $51,000) $97,000

Interest income 2,100

Contributions to traditional IRAs (5,000)

Adjusted gross income $94,100

Less: Itemized deductions $11,500

Personal exemptions (2 X $3,100) 6,200

Dependency exemptions (3 X $3,100) 9,300 (27,000)

Taxable income $67,100

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 falls under the full-time student exception to the gross income test. As to the same test, Kevin satisfies the under-the-age-of-19 test. 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 3-6, 3-8, 3-14, Example 35, Exhibits 3-1 and 3-2, and Figure 3-1

37. a. Wages $2,100

Bank interest 1,150

Bond interest (City of Chicago bond interest is tax-exempt) -0-

Gross income $3,250

Less: Standard deduction* (2,350)

Personal exemption** (-0-)

Taxable income $ 900

b. Bank interest $1,150

Bond interest -0-

Total unearned income $1,150

Minus: $800 + $800 standard deduction (1,600)

Income taxed at parents’ rate $ -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 2004 tax liability is $90 ($900 taxable income X 10%).

pp. 3-9, 3-10, 3-20 to 3-22, Exhibits 3-1 and 3-2, and Example 10.

38. a. In Louisiana, John and Irene are each deemed to have income of $1,600 (50% X $3,200). Consequently, neither would violate the gross income test of $3,100. They both can be claimed as dependents by Walter and Nancy. Example 43

b. In New Jersey, only John can be claimed as a dependent. Irene does not meet the gross income test (i.e., $3,200 exceeds $3,100). She does not qualify under the student exception and is not under 19 years of age. Example 42

39. 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 $1,023 tax on the $9,200 taxable income [($7,150 X 10%) + ($2,050 X 15%)].

The tax saving to the family unit in 2004 if Don transfers the duplex would be $2,277 ($3,300 – $1,023), 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

40. a. Gross income $70,000

Short-term capital loss (3,000)

Cash prize 2,000

AGI $69,000

Less: Personal and dependency exemptions (6 X $3,100) (18,600)

Standard deduction (9,700)

Taxable income $40,700

Tax on $40,700 using surviving spouse rate schedule: $1,430 + 15%($40,700 – $14,300) = $5,390

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 $80,000

Contribution to traditional IRA (3,000)

AGI $77,000

Less: Personal and dependency exemptions (4 X $3,100) (12,400)

Standard deduction (head of household) (7,150)

Taxable income $57,450

Tax on $57,450 using head of household rate schedule: $5,325 + 25%($57,450 – $38,900) = $9,963

Although Rosalyn does not meet the relationship test, she is a member of Penny’s household. Jerold and Zoe meet the relationship test. Jerold is not a U.S. citizen or resident but is a resident of Canada.

c. Gross income and AGI (gifts and inheritances are not taxable) $105,000

Less: Personal and dependency exemptions (3 X $3,100) (9,300)

Itemized deductions (16,000)

Taxable income $ 79,700

Tax on $79,700 using married filing jointly rate schedule: $8,000 + 25%($79,700 – $58,100) = $13,400

An ex-wife does not meet the relationship test but an ex-stepson does.

pp. 3-6, 3-8, 3-13, 3-14, 3-17, 3-26 to 3-28, 3-31, Figure 3-1, and Tables 3-1 and 3-2

41. Salary income ($49,000 + $50,000) $ 99,000

Interest income ($900 + $2,300) 3,200

AGI $102,200

Personal and dependency exemptions (5 X $3,100) (15,500)

Itemized deductions (13,600)

Taxable income $ 73,100

The tax on $73,100 using the tax rate schedules applicable to married persons filing jointly is: $8,000 + 25%($73,100 – $58,100) = $11,750

The $1,200 of interest from state bonds and the $30,000 gift are exclusions from gross income. As Odette meets the relationship test, she need not live with the Holts. Courtney qualifies as a dependent as she comes under the full-time student exception for a child under age 24 for the gross income test. (Five months meets the definition of “full-time.”) Dennis does not qualify for the under the age exception (less than 19 years old), while Wade does—Wade is a “child” of the Holts while Dennis is not.

pp. 3-13, 3-14, 3-17, and Exhibits 3-1 and 3-2

42. Unearned income $1,800

Minus: $800 base amount + $800 standard deduction (1,600)

Unearned income taxed at parents’ rate $ 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 $2,100

Interest income 1,800

Gross income $3,900

Less: Personal exemption - 0 -

Less: Standard deduction [greater of $800 or $2,100 (earned

      income) + $250] (2,350)

Taxable income $1,550

Less: Unearned income taxed at parents’ rate (200)

Income taxed at Ginni’s rate $1,350

Ginni’s tax rate X 10%

Tax at Ginni’s rate $ 135

Ginni’s total tax: $50 (unearned income taxed at parents’ rate) + $135 (taxed at Ginni’s rate) = $185.

pp. 3-20 to 3-22 and Example 28

43. Unearned income (interest) $11,100

Base amount not taxed at parents’ rate (800)

Standard deduction (800)

Unearned income taxed at parents’ rate $ 9,500

Nash’s parents cannot make the parental election. pp. 3-20 to 3-22 and Example 28

44. Willis, Hoffman, Maloney, and Raabe, CPAs

5191 Natorp Boulevard

Mason, OH 45040

November 9, 2004

Mr. and Mrs. Gabe Malat

140 State Street

Russellville, AR 72801

Dear Mr. and Mrs. Malat:

Your recent letter requested that I determine what the Federal income tax liability will be depending on whether you choose to file separately or jointly for 2004.

Based on the information that was provided, by filing a joint return the tax is $32,266. On separate returns, the tax is $17,392.75 for Lily and $14,872.75 for Gabe, for a combined total of $32,266 (rounded). In summary, the same tax results whether you file jointly or as married persons filing separately. Although there are some tax disadvantages for married persons who file separately, none of these apply in your case. Moreover, please do not continue to rely on my advice beyond your filing status for year 2004.

If I can be of further service to you, do not hesitate to contact me.

Sincerely,

John M. Camp

Tax Manager

[Note: In the interest of diplomacy, the letter does not attempt to correct the Malat’s misconception about the marriage penalty. The penalty came about because some married couples paid higher taxes than if they had stayed single. The Malats appear to associate the penalty with what used to be the horrendous tax result when married persons filed separately. In passing, it should be mentioned that the Malats, under the same facts, would have paid $704 less tax had they been single. Thus, the marriage penalty is not entirely gone!]

pp. 3-26 and 3-27

45. a. Sam and Lana need not file since their gross income of $16,500 is less than the $17,800 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 $4,850 (his standard deduction).

c. Mike is required to file since his gross income of $9,200 is more than the $9,150 filing requirement.

d. Marge is required to file. Her gross income is less than $7,950, but her net earnings from self-employment are more than $400.

Taxpayers in a. and b. should file, even if a return is not required, to obtain a refund if any income tax was withheld.

pp. 3-22, 3-23, 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 $4,850.

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 $4,050 [$2,850 (the greater of $800 or the sum of earned income + $250) + $1,200 (additional standard deduction for being blind)].

e. Pat must file a tax return since she has net self-employment earnings of $400 or more.

pp. 3-22 and 3-23

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. 3-26 to 3-28 and Examples 32 to 34

48. a. Winston can use head of household filing status. As long as the child is not married, being a dependent is not necessary.

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.

pp. 3-25 to 3-28 and Examples 33 and 34

49. In 2002, Sue is eligible to use the married, filing jointly status. Henry’s executor must consent to filing a joint return.

In 2003, Sue’s filing status is qualifying widow (surviving spouse), since Mike qualifies as Sue’s dependent because he is a full time student under 24 years old.

In 2004, Mike became a part-time student and earned over $3,100; therefore, his mother cannot claim him as a dependent. Sue’s filing status is head of household for 2004.

pp. 3-14, 3-26, 3-28, and Examples 32 and 33

50. Tracy may file as a head of household since she maintains a home which is the residence of an unmarried child. It is not necessary that the unmarried child be a dependent in order for Tracy to qualify as a head of household. Tracy cannot file as a surviving spouse because Gary does not qualify as her dependent. Even though Gary is classified as a full-time student [August–December (5 months)], he is not under age 24, and his gross income exceeds $3,100. Therefore, Tracy can claim only one exemption. pp. 3-14, 3-28, and Example 33

51. a. Tax on short-term capital gain (28% X $6,000) $1,680

Tax on long-term capital gains of $3,000 + $7,000

(15% X $10,000) 1,500

Total tax $3,180

The long-term loss of $1,000 on the sale of the powerboat is a nondeductible personal loss.

b. Tax on short-term capital gain (15% X $6,000) $ 900

Tax on long-term capital gain (5% X $10,000) 500

Total tax $1,400

pp. 3-29 to 3-31 and Examples 35 to 39

52. a. The loss on the Crow Corporation stock of $8,000 is first applied to the gain on the painting of $10,000. The painting is a collectible taxed at a 28% rate. After this combination, the end result is:

Tax on remaining collectible gain (28% X $2,000) $ 560

Tax on land gain (15% X $6,000) 900

Total tax on all gains $1,460

b. Use the same netting procedure, then tax the net collectible gain at 15% and the land gain at 5%. Thus, $300 (15% X $2,000) + $300 (5% X $6,000) = $600.

pp. 3-30, 3-31, and Example 39

53. If Amelia does nothing, her taxes for both years would be as follows:

  2004    2005  

AGI $60,000 $61,000

Less: Personal exemption (3,100) (3,100)

Standard deduction (4,850) (4,850)

Taxable income $52,050 $53,050

The income tax for 2004 is $9,750 [$4,000 + 25%($52,050 – $29,050)] and for 2005 is $10,000 [$4,000 + 25%($53,050 – $29,050)] for a total of $19,750 ($9,750 + $10,000).

If Amelia prepays her church pledge, her taxes for both years would be as follows:

  2004    2005  

AGI $60,000 $61,000

Less: Personal exemption (3,100) (3,100)

Itemized deductions

($1,300 + $1,100 + $4,800) (7,200) -0-

Standard deduction -0- (4,850)

Taxable income $49,700 $53,050

The income tax for 2004 is $9,163 [$4,000 + 25%($49,700 – $29,050)] and for 2005 is $10,000 [$4,000 + 25%($53,050 – $29,050)] for a combined total of $19,163 ($9,163 + $10,000).

Consequently, Amelia’s prepayment of her church pledge in 2004 saves her $587 ($19,750 – $19,163) in income taxes.

p. 3-32

CUMULATIVE PROBLEMS

54. Salaries ($45,000 + $49,000) (Note 1) $94,000

Interest income—

CD at Bank America (Note 2) $2,100

Interest on loan (Note 3) 1,000 3,100

Property sale (Note 4) (3,000)

AGI $94,100

Itemized deductions ($3,600 + $4,800 +$2,400) (Note 5) (10,800)

Personal and dependency exemptions (4 X $3,100) (Note 6) (12,400)

Taxable income $70,900

Notes

1) Gross income does not include life insurance proceeds ($50,000), gifts ($22,000), and inheritances ($97,100).

2) Gross income does not include interest on municipal bonds ($1,300).

(3) Although the loan repayment ($10,000) is a nontaxable return of capital, the interest ($1,000) the brother paid is includible in gross income.

(4) The sale of the GE stock resulted in a $3,500 ($15,000 cost – $11,500 selling price) short-term capital loss. But only $3,000 of an excess capital loss can be deducted each year—the $500 unused balance is carried forward. The garage sale resulted in a nondeductible personal loss of $7,100 ($900 – $8,000).

(5) Deductions are itemized as $10,800 exceeds the standard deduction of $9,700.

(6) No dependency exemption is allowed for Fletcher as his gross income exceeds $3,100—the taxable portion of the scholarship, or $3,200, is what is considered. In spite of Fletcher’s full-time student status, he is not under 24 years of age. Cole falls under the full-time student exception to the gross income test, while Gina falls under the less than 19 years old exception.

55. Part I. Tax Computation

Salary $62,000

Interest income ($5,700 + $6,300) 12,000

Less alimony payments ($300 X 11 payments) (3,300)

AGI $70,700

Less: Standard deduction (Note 1) (7,000)

Personal and dependency exemptions ($3,050 X 2) (6,100)

Taxable income $57,600

Tax on taxable income (see Tax Tables) head of household $10,101

Less amounts withheld of $10,900 (10,900)

Net tax payable (or refund due) for 2003 ($ 799)

Note 1: The standard deduction of $7,000 for a head of household is greater than the itemized deductions of $6,400 ($3,300 + $1,300 + $1,800).

See the tax return solution beginning on page 3-20 of the Solutions Manual.

Part II. Tax Planning

Willis, Hoffman, Maloney, and Raabe, CPAs

5191 Natorp Boulevard

Mason, OH 45040

February 26, 2004

Mr. Horace Fern

321 Grant Avenue

Cheyenne, WY 82002

Dear Horace:

I am enclosing your completed tax return for 2003. Please sign on page 2 of Form 1040 and use the enclosed envelope for mailing the return to the IRS by April 15, 2004.

Regarding your tax position for 2004, 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:

2003 taxable income $57,600

Taxable income for 2004 will increase because of:

Increase in income for 2004 (salary) 6,200

Decrease in deductions:

Exemption for mother claimed in 2003 3,050

Alimony paid to ex-wife 3,300

Itemized deductions of $6,400 in 2004 (standard deduction

is less) versus standard deduction in 2003 of $7,000 600

Taxable income for 2004 will decrease because of:

Increase in exemption amount for 2004 (50)

Projected taxable income for 2004 $70,700

Tax on projected 2004 taxable income using tax rate schedule applicable to single taxpayers:

$14,325 + 28%($70,700 – $70,350) $14,423

Less: 2003 tax (10,101)

Increase in tax $ 4,322

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 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

The answers to the Research Problems are incorporated into the 2005 Comprehensive Volume of the Instructor’s Guide with Lecture Notes to Accompany WEST FEDERAL TAXATION: COMPREHENSIVE VOLUME.

55.

55. continued

55. continued

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