Chapter 06 - Individual Deductions

Chapter 6 Individual Deductions SOLUTIONS MANUAL Problems

37. [LO 1] Hardaway earned $100,000 of compensation this year. He also paid (or had paid for him) $3,000 of health insurance. What is Hardaways AGI in each of the following situations (ignore the effects of Social Security and self-employment taxes)? a. Hardaway is an employee, and his employer paid Hardaways $3,000 of health insurance for him as a nontaxable fringe benefit. Consequently, Hardaway received $97,000 of taxable compensation and $3,000 of nontaxable compensation. Hardaway is a self-employed taxpayer, and he paid $3,000 of health insurance himself. He is not eligible to participate in an employer-sponsored plan. Hardaways AGI is $97,000, consisting of the $97,000 of taxable compensation he received from his employer. Hardaways AGI is $97,000 (the same as in part a), consisting of $100,000 of taxable earnings minus $3,000 for AGI deduction for the health insurance.

b.

a. b. 39.

[LO 1] Lionel is an unmarried law student at State University Law School, a qualified educational institution. This year Lionel borrowed $24,000 from Counti Bank and paid interest of $1,440. Lionel used the loan proceeds to pay his law school tuition. Calculate the amounts Lionel can deduct for interest on higher education loans under the following circumstances: a. b. c. d. Lionels AGI before deducting interest on higher education loans is $50,000. Lionels AGI before deducting interest on higher education loans is $69,000. Lionels AGI before deducting interest on higher education loans is $90,000. Lionels AGI is $50,000 before deducting interest on higher education loans. Lionel used $16,000 of the loan to pay law school tuition and $8,000 of the loan to purchase a car. The maximum interest deduction is the amount paid up to $2,500. The deduction is phased out as AGI exceeds $60,000 (before applying the interest deduction). Consequently, because his AGI is below the trigger amount for the phase-out, Lionel can deduct $1,440, which is the lesser of (1) $2,500 or (2) $1,440 (the amount of interest expense he paid). Lionel paid $24,000 of qualified educational expenses. Because his modified AGI ($50,000 - $1,440 deduction for interest on higher education loan = $48,560) is less than the trigger for the deduction for qualified education expense phase-out ($65,000), Lionel can deduct $4,000 for qualified

a.

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education expenses, which is the lesser of (1) $4,000 or (2) $24,000 (qualified education expenses paid). b. Lionel can deduct $576 of qualified educational interest expense computed as follows: Amount Explanation $69,000 1,440 Lesser of amount paid or $2,500 60% [(1) 60,000] / 15,000, limited to 100 percent 864 (2) x (3) $576 (2) (4)

Description (1) Modified AGI (2) Amount of interest paid up to $2,500 (3) Phase-out (reduction) percentage (4) Phase-out amount (reduction in maximum) Deductible interest expense

Since Lionels modified AGI (($69,000 - $1,000 deduction for interest on higher education loan = $68,000) exceeds $65,000 but is less than or equal to $80,000, Lionel can also deduct $2,000 of qualified education expenses, which is the lesser of (1) $2,000 or (2) $24,000 (qualified education expenses paid). c. Lionel is not allowed to deduct any qualified educational interest expense computed as follows: Amount Explanation $90,000 1,440 Lesser of amount paid or $2,500 100% [(1) 60,000] / 15,000, limited to 100 percent 1,440 (2) x (3) $0 (2) (4)

Description (1) Modified AGI (2) Amount of interest paid up to $2,500 (3) Phase-out (reduction) percentage (4) Phase-out amount (reduction in maximum) Deductible interest expense

Lionel is also not allowed to deduct any qualified education expenses because his modified AGI ($90,000) exceeds $80,000.

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d.

As in part a., Lionel is allowed a $4,000 deduction for AGI for qualified educational expenses. However, because he used only $16,000 of the $24,000 loan proceeds for qualified educational expenses (the car doesnt qualify), he is allowed to deduct as a for AGI deduction only 2/3rds of the interest on the loan as qualified educational interest. Consequently, his interest deduction is limited to $960 ($1,440 x 2/3).

41.

[LO 1 2] In each of the following independent cases, indicate the amount (1) deductible for AGI, (2) deductible from AGI, and (3) neither deductible for nor deductible from AGI before considering income limitations or the standard deduction. a. b. c. d. a. b. c. d. Ted paid $8 rent on a safety deposit box at the bank. In this box he kept the few shares of stock that he owned. Tyler paid $85 for minor repairs to the fence at a rental house he owned. Timmy paid $545 for health insurance premiums this year. Timmy is employed fulltime and his employer paid the remaining premiums as a qualified fringe benefit. Tess paid $850 for self-employment taxes and $1,150 of state income taxes on her consulting income. Deduction from AGI investment expense deducted as a miscellaneous itemized deduction Deduction for AGI rental/royalty expense The health insurance is from AGI medical itemized deduction but subject to an AGI floor limitation. Half of the SE taxes are deductible for AGI but the state income taxes are deductible from AGI (an itemized deduction).

42.

[LO 1 2] In each of the following independent cases, indicate the amount (1) deductible for AGI, (2) deductible from AGI, and (3) neither deductible for nor deductible from AGI before considering income limitations or the standard deduction. a. b. c. Fran spent $90 for uniforms for use on her job. Her employer reimbursed her for $75 of this amount under an accountable plan. Timothy, a plumber employed by ACE Plumbing, spent $65 for small tools to be used on his job, but he was not reimbursed by ACE. Jake is a perfume salesperson. Because of his high pay, he receives no allowance or reimbursement from his employer for advertising expenses even though his position requires him to advertise frequently. During the year, he spent $2,200 on legitimate business advertisements. Trey is a self-employed special-duty nurse. He spent $120 for uniforms. Mary, a professor at a community college, spent $340 for magazine subscriptions. The magazines were helpful for her research activities but she was not reimbursed for the expenditures.
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d. e.

Chapter 06 - Individual Deductions

f.

Wayne lost $325 on the bets he made at the race track, but he won $57 playing online poker. a. $15 from AGI (miscellaneous itemized deduction as unreimbursed employee business expense). Income and expenses associated with the $75 reimbursement completely offset each other and are ignored. Note that the accountable plan only reimburses deductible expenses. from - miscellaneous itemized deduction as employee business expense from - miscellaneous itemized deduction as employee business expense for - trade expense assuming that the special duty uniforms cannot be adapted to normal use. $340 from AGI as miscellaneous itemized deduction as employee business expenses $57 from AGI as a miscellaneous itemized deduction not subject to 2% floor. Waynes gambling loss deduction is limited to his winnings.

b. c. d. e. f. 44.

[LO 2] Simpson is a single individual who is employed full-time by Duff Corporation. This year Simpson reports AGI of $50,000 and has incurred the following medical expenses: Dentist charges Physician's charges Optical charges Cost of eyeglasses Hospital charges Prescription drugs Over-the-counter drugs Medical insurance premiums a. b. $ 900 1,800 500 300 2,100 250 450 775

Calculate the amount of medical expenses that will be included with Simpsons itemized deductions after any applicable limitations. Suppose that Simpson was reimbursed for $650 of the physician's charges and $1,200 for the hospital costs. Calculate the amount of medical expenses that will be included with Simpsons itemized deductions after any applicable limitations. All expenses are qualified medical expenses except for the over-the-counter drugs. Hence, Simpsons medical expense deduction is $6,625 less $3,750 (7.5 percent * 50,000) = $2,875 and this amount is included with Simpsons other itemized deductions.

a.

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b.

Same as a. except Simpsons medical expenses are first reduced by reimbursements $6,625 less $1,850 then reduced by the floor limit $3,750 (7.5 percent* 50,000) = $1,025 and this amount is included with Simpsons other itemized deductions.

47.

[LO 1 2] Charles has AGI of $50,000 and has made the following payments related to (1) land he inherited from his deceased aunt and (2) a personal vacation taken last year. Calculate the amount of taxes Charles may include in his itemized deductions for the year under the following circumstances: State inheritance tax on the land County real estate tax on the land School district tax on the land City special assessment on the land (new curbs and gutters) State tax on airline tickets (paid on vacation) Local hotel tax (paid during vacation) a. b. c. a. Suppose that Charles holds the land for appreciation. Suppose that Charles holds the land for rent. Suppose that the vacation was actually a business trip for his employer. Deductible taxes = $2,190. The inheritance tax, the airline tax, and the hotel tax are nondeductible personal expenses. The special assessment is also not deductible because it is capitalized to the value of the property. The $2,190 of taxes are deductions for AGI associated with rental property. The inheritance tax and the special assessment are still not deductible (as in a. above). However, now the airline tax and the hotel tax are deductible unreimbursed business expenses (miscellaneous itemized deduction subject to 2% AGI floor). $ 1,200 1,500 690 700 125 195

b. c.

50.

[LO 2] This year Randy paid $28,000 of interest (Randy borrowed $450,000 to buy his residence, and it is currently worth $500,000). Randy also paid $2,500 of interest on his car loan and $4,200 of margin interest to his stockbroker (investment interest expense). How much of this interest expense can Randy deduct as an itemized deduction under the following circumstances? a. b. a. Randy received $2,200 of interest this year and no other investment income or expenses. Randy had no investment income this year. Randy can deduct $30,200. The interest on the car loan is nondeductible personal interest but Randy may deduct all $28,000 of his interest on the home loan as an itemized deduction. The $4,200 of margin interest is likely investment interest, and this itemized deduction is limited to net investment income. Because the $2,200 of interest income qualifies as investment income and Randy apparently has no other

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investment expenses, the investment interest expense would be limited to his $2,200 in net investment income. b. Randy may deduct all $28,000 of his interest on the home loan as an itemized deduction. Randy apparently has no net investment income. Hence, the investment interest would not be deductible this year and would carry forward to next year.

59.

[LO 3] Stephanie is a twelve-year old who often assists neighbors on weekends by babysitting their children. Calculate the 2011 standard deduction Stephanie will claim under the following independent circumstances (assume that Stephanies parents will claim her as a dependent). a. b. c. a. b. c. Stephanie reported $850 of earnings from her babysitting. Stephanie reported $1,500 of earnings from her babysitting. Stephanie reported $6,200 of earnings from her babysitting. Stephanie can claim a standard deduction of $1,150, the greater of the minimum standard deduction ($950) or $300 plus her earned income ($850). Stephanie can claim a standard deduction of $1,800, the greater of the minimum standard deduction ($950) or $300 plus her earned income ($1,500). Stephanie can claim a standard deduction of $5,800, $300 plus her earned income ($6,200) but limited to the maximum standard deduction for her filing status, (single is $5,800 for 2011).

60.

[LO 1 LO 2 LO 3] {Research} Tammy teaches elementary school history for the Metro School District. In 2011 she has incurred the following expenses associated with her job: Noncredit correspondence course on history Teaching publications Tuition for university graduate course in physics Transportation between school and home Photocopying class materials Transportation from school to extracurricular activities Cost of lunches eaten during study halls $ 900 1,800 1,200 750 100 110 540

Tammys base salary is $45,000, and she receives a $200 salary supplement to help her cover expenses associated with her school extracurricular activities. a. b. Identify the amount and type (for AGI or from AGI) of deductible expenses. Calculate Tammys AGI and taxable income for 2011 assuming she files single with one personal exemption.

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a.

The commuting expense and lunches are personal and not deductible. The tuition for the university graduate course is eligible for the qualified education expense deduction (IRC Sec. 222(d) and IRC Sec. 25A(f)), but the correspondence course is not likely to qualify as a qualified education deduction, because it is not for credit. $250 of the publications qualify for the educators deduction (IRC Sec. 62(d)), but the remaining expenses are deductible as employee business expenses under miscellaneous itemized deductions. Noncredit correspondence course Teaching publications Tuition for university graduate course in physics Transportation between school and home Photocopying class materials Transportation to extracurricular activities $ 900 1,550 250 1,200 750 100 110 From From For For Not From From

b.

Tammys taxable income is $34,400. Tammy would elect the standard deduction in lieu of itemizing. $ $ $ 45,200 1,450 43,750 5,800 3,700 34,250 Qualified

Salary and supplement education expense (graduate tuition) AGI Standard deduction Personal exemption Taxable income

Comprehensive Problems
61. This year Evan graduated from college, and took a job as a deliveryman in the city. Evan was paid a salary of $63,500 and he received $700 in hourly pay for part-time work over the weekends. Evan summarized his expenses below. Cost of moving his possessions to the city Interest paid on accumulated student loans Cost of purchasing a delivery uniform Contribution to State University deliveryman program $ 1,200 2,800 1,100 1,300

Calculate Evans AGI and taxable income if he files single with one personal exemption. \ AGI is $61,000; Taxable income is $51,500, computed as follows:

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Salary Part-Time Hourly Pay Gross Income Less Moving Expense Deduction Modified AGI (for student interest) Student Loan Interest Deduction AGI Standard Deduction Personal Exemption Taxable Income

$ 63,500 + 700 $ 64,200 - 1,200 $ 63,000 - 2,000 $ 61,000 - 5,800 - 3,700 $ 51,500

Evans modified AGI for determining the deductibility of his educational loan interest is $3,000 beyond the threshold amount of $60,000, and hence his deduction for educational loan interest is subject to a phase-out. Evans maximum deduction before the phase-out is $2,500 (the amount of interest paid ($2,800) up to $2,500). The ratio is $3,000/$15,000 resulting in a phase-out of 20% percent of the maximum deduction of $2,500. Hence, Evan can only deduct $2,000 of the student loan interest ($2,500-$500). Hence, Evans AGI is $61,000. The uniform would qualify as an employee business deduction, but would be eliminated by the 2% floor on miscellaneous itemized deductions. The charitable contribution would be deductible as an itemized deduction, but Evan would choose his standard deduction instead of itemizing. 62. Read the following letter and help Shady Slim with his tax situation. Please assume that gross income is $172,900 for purposes of this problem.

December 31, 2011 To the friendly student tax preparer: Hi, its Shady Slim again. Im told that you need some more information from me in order to complete my tax return. Im an open book! Ill tell you whatever I think you need to know. Let me tell you a few more things about my life. As you may recall, I am divorced from my wife, Alice. I know that its unusual, but I have custody of my son, Shady, Jr. The judge owed me a few favors and I really love the kid. He lives with me full-time and my wife gets him every other weekend. I pay the vast majority of my sons expenses. I think Alice should have to pay some child support, but she doesnt have to pay a dime. The judge didnt owe me that much, I guess. I had to move this year after getting my job at Roca Cola. We moved on February 3 of this year, and I worked my job at Roca Cola for the rest of the year. I still live in the same state, but I moved 500 miles away from my old house. I left a little bit early to go on a house-hunting trip that cost me a total of $450. I hired a moving company to move our stuff at a cost of $2,300. Junior and I got a hotel room along the way that cost us $40 (I love Super 8!). We spent $35 on meals on the way to our new home. Oh yeah, I took Junior to a movie on the way and that cost $20.
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Can you believe Im still paying off my student loans, even after 15 years? I paid a total of $900 in interest on my old student loans this year. Remember when I told you about that guy that hit me with his car? I had a bunch of medical expenses that were not reimbursed to me by the lawsuit or by my insurance. I incurred a total of $20,000 in medical expenses, and I was only reimbursed for $11,000. Good thing I can write off medical expenses, right? I contributed a lot of money to charity this year. Im such a nice guy! I gave $1,000 in cash to the March of Dimes. I contributed some of my old furniture to the church. It was some good stuff! I contributed a red velvet couch and my old recliner. The furniture is considered vintage and is worth $5,000 today (the appraiser surprised me!), even though I only paid $1,000 for it back in the day. When I contributed the furniture, the pastor said he didnt like the fabric and was going to sell the furniture to pay for some more pews in the church. Some people just have no taste, right? Roca Cola had a charity drive this year and I contributed $90. Turns out, I dont even miss it, because Roca Cola takes it right off my paycheck every month$15 a month starting in July. Oh, one other bit of charity from me this year. An old buddy of mine was down on his luck. He lost his job and his house. I gave him $500 to help him out. I paid a lot of money in interest this year. I paid a total of $950 in personal credit card interest. I also paid $13,000 in interest on my home mortgage. I also paid $2,000 in real estate taxes for my new house. A few other things I want to tell you about last year. Someone broke into my house and stole my kids brand new bicycle and my set of golf clubs. The total loss from theft was $900. I paid $100 in union dues this year. I had to pay $1,000 for new suits for my job. Roca Cola requires its managers to wear suits every day on the job. I spent a total of $1,300 to pay for gas to commute to my job this year. Oh, this is pretty cool. Ive always wanted to be a firefighter. I spent $1,000 in tuition to go to the local firefighters school. I did this because someone told me that I can deduct the tuition as an itemized deduction, so the money would be coming back to me. That should be all the information you need right now. Please calculate my taxable income. Youre still doing this for free, right? Taxable income is $145,975, computed as follows:

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Gross Income Less Moving Expenses: Mileage (500 x 19) Moving company Lodging AGI Itemized Deductions: Medical Expenses Mortgage Interest Real Estate Taxes Charitable Contributions Misc. Itemized Deductions Taxable income before exempions Personal & Dependency exemptions Taxable Income

$ 172,900 $ 95 2,300 40

- 2,435 $ 170,465

0 13,000 2,000 2,090 0

- 17,090 $ 153,375 - 7,400 $ 145,975

Notes: 1. House-hunting trip, meals, and movie are not deductible moving expenses. 2. 3. 4. 5. 6. 7. 8. Student loan interest is not deductible because AGI exceeds the threshold amount of income. Medical expenses do not exceed the floor limitation of 7.5 percent of AGI so are nondeductible. Personal credit card interest is not deductible. Slim can deduct the $1,000 cash donation, the $90 payroll deduction and the basis of the furniture he contributed (capital gain property put to unrelated use). Casualty losses do not exceed floor limitations ($100 and 10 percent of AGI) thus, they are not deductible. Miscellaneous itemized deductions: union dues of $100 don't exceed the 2% threshold. Other non-deductible items: clothing for work, commuting expenses, firefighter education expenses.

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