CHAPTER 2 TAX DETERMINATION; PERSONAL …isu.indstate.edu/acharmo/smpdf/CH02.pdfTAX DETERMINATION;...

CHAPTER 2

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 Unchanged 12 Current income tax rates Unchanged 23 Gross income: exclusions New 4 Gross income: inclusions New 5 Income tax: international considerations New 6 Issue ID Unchanged 67 Issue ID Unchanged 78 Dependents and the determination of their

standard deduction and personal exemptions Unchanged 8

9 Dependency exemption: treatment of scholarships for the support and gross income tests

Unchanged 9

10 Dependency exemption: multiple support agreement Unchanged 1011 Dependency exemption: gross income and

relationship tests New

12 Issue ID New 13 Issue ID Unchanged 1314 Stealth taxes Unchanged 1415 Characteristics of the kiddie tax Unchanged 1516 Filing requirement Unchanged 1617 Marriage penalty Unchanged 1718 Marriage penalty Unchanged 1819 Surviving spouse status Unchanged 1920 Filing status Unchanged 2021 Issue ID Unchanged 2122 Treatment of capital gains Unchanged 2223 Treatment of capital gains Unchanged 2324 Capital loss tax treatment Unchanged 24

2-1

2-2 2004 Comprehensive Volume/Solutions Manual

Status: Q/P Question/ Present in Prior Problem Topic Edition Edition

25 Capital transactions: treatment of collectibles Unchanged 2526 Issue ID New 27 Multiple support agreement: planning for Unchanged 27

* 28 Taxable income calculation Unchanged 28* 29 Taxable income calculation New * 30 Taxable income calculation New

31 Standard deduction of dependent New 32 Personal and dependency exemptions Unchanged 3233 Personal and dependency exemptions Unchanged 3334 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 Unchanged 37

38 Dependency exemptions: joint return test Unchanged 3839 Dependent’s tax liability—unearned income Unchanged 39

* 40 Tax liability calculations New * 41 Taxable income calculation New * 42 Child’s income taxed at parents’ rate New * 43 Child’s income taxed at parents’ rate Unchanged 43* 44 Marriage penalty Unchanged 44

45 Filing requirements Unchanged 4546 Filing requirements Unchanged 4647 Filing status determination New 48 Filing status determination New 49 Filing status determination Unchanged 4950 Filing status determination; dependency exemptions Unchanged 50

* 51 Capital transactions: determination of tax Unchanged 51* 52 Capital transactions: determination of tax Unchanged 52

53 Tax planning: alternating years for itemized deductions with standard deduction

Unchanged 53

* 54 Cumulative New * 55 Cumulative Unchanged 55 *The solution to this problem is available on a transparency master.

Tax Determination; Exemptions; Overview of Property Transactions 2-3

CHECK FIGURES

28.a. $42,900. 28.b. $32,650. 28.c. $0. 28.d. $650. 29. $19,850. 30. $54,400. 31.a. $4,750. 31.b. $3,450. 31.c. $750. 31.d. $850. 31.e. $3,200. 32.a. Two. 32.b. Two. 32.c. Two. 32.d. Four. 33.a. Three. 33.b. Two. 33.c. Three. 34.a. Four. 34.b. Four. 34.c. Three. 34.d. Two. 35. $23,607. 36. $67,350. 37.a. $900. 37.b. $90. 39. Transferring the duplex saves

$2,412. 40.a. $7,719. 40.b. $9,744. 40.c. $2,693. 41. $13,511.

42. Taxable income $1,550; tax $206. 43. $9,600. 44. Postponing marriage saves $1,670. 45.a. Sam and Lana need not file. 45.b. Bobby is not required to file. 45.c. Mike is not 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. 2001 married filing joint; 2002

surviving spouse; 2003 head of household.

50. Head of household; one. 51.a. $2,600. 51.b. $1,300. 52.a. $880. 52.b. $450. 53. Yes; deductions total $11,050 versus

$9,450. 54. Taxable income $63,470. 55. Refund due $1,481.


DISCUSSION QUESTIONS 1. e. Income (broadly conceived). d. Exclusions.

g. Gross income. c. Deductions for AGI. b. Adjusted gross income. f. The greater of the standard deduction or itemized deductions. a. Personal and dependency exemptions. h. Taxable income. Otherwise stated: e. – d. = g. – c. = b. – f. – a. = h. p. 2-2 and Figure 2-1 2. The Tax Relief Reconciliation Act of 2001 made two major changes. First, a new 10%

bracket was created. Second, the rates above the 15% bracket (i.e., 28%, 31%, 36%, and 39.6%) are reduced. The rate reduction is phased in over the period of 2001 to 2006. After the phase-in, the brackets will be: 10%, 15%, 25%, 28%, 33%, and 35%. pp. 2-3, 2-17, and Footnote 1

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

2-1 and 2-2 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. 2-3, 2-5, and Exhibits 2-1 and 2-2 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. 2-5.

6. a. The moving expenses are deductions for AGI. Consequently, they reduce AGI.

Since medical expenses that exceed 7.5% of AGI are deductible, a lower AGI means more expenses will qualify.

b. If a taxpayer chooses the standard deduction alternative, the amount of itemized

deductions is of no consequence. pp. 2-5, 2-6, and Examples 3 and 4 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. 2-6 to 2-8 and Tables 2-1 and 2-2

8. a. This is the minimum standard deduction allowed for a dependent. b. Earned income plus $250 becomes the standard deduction of a dependent if this

amount exceeds $750. However, the basic standard deduction amount is limited to the amounts in Table 2-1.

c. In no event can the basic standard deduction of a dependent exceed that allowed a

single taxpayer ($4,750 for 2003).


d. Additional standard deduction is allowed for a dependent who is blind and/or is at least age 65.

p. 2-9 and Examples 8 to 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. 2-11 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. 2-14

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. 2-12, 2-13, 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. pp. 2-13 and 2-14

12. a. Adriana and Hector qualify for 2003.

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. 2-13, 2-14, 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. 2-14

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.


See the Tax in the News on p. 2-15. 15. 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 $1,500. 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. 2-20 to 2-22

16. a. In 2003, a single individual who is age 65 or over and blind would have a filing

requirement of $8,950 ($4,750 standard deduction + $1,150 additional standard deduction for age + $3,050 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. 2-7, 2-8, 2-23, and Tables 2-1, 2-2, and 2-4

17. a. Depending on the circumstances, a joint return can generate more income tax than

if the taxpayers were not married and filing in their individual capacities, either as single or head of household.

b. Some persons have moral qualms about a tax situation that tends to discourage

marriage. c. It is most likely to occur when both spouses have income, generally, of

approximately the same amount. Higher income levels are most vulnerable. d. The Tax Relief Reconciliation Act of 2001 attempts to mitigate the penalty by

increasing the amount of the standard deduction and expanding the scope of the 15% tax bracket for married taxpayers filing a joint return.

e. The relief provided is deferred and phased in over a five-year period beginning in

2005.

pp. 2-28, 2-29, and Example 30 18. The solution to the marriage penalty does not lie with married persons filing separate

returns. In fact, this filing status most likely will yield a combined income tax liability that is higher than any result reached by filing jointly. When and if it materializes, the marriage penalty results from marrying and filing a joint return rather than remaining single. pp. 2-27, 2-28, and Example 30

19. For 2003, 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 2004 and 2005, 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. 2-28 and Example 31

20. a. Head of household. Example 32 b. Single. p. 2-29 c. Head of household. p. 2-29 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. 2-29 and Example 31 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. p. 2-29 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. 2-31, 2-32, and Example 34

23. No. If the taxpayer is in the 15% tax bracket, these gains are taxed at only 10% (or in a

limited case at 8%). p. 2-32 and Example 36 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 2004 as a long-term capital loss. p. 2-32 and Example 39

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. 2-31, 2-32, and Example 38 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. 2-14 and 2-29

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 $3,050). As in part a. above, Marcie qualifies for head of household filing status. p. 2-35 and Example 42

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. 2-35 and Example 43

PROBLEMS 28. a. Adjusted gross income $60,000 Less: Standard deduction (7,950) Personal and dependency exemptions (3 X $3,050) (9,150) Taxable income $42,900 pp. 2-6 to 2-8, Figure 2-1, and Table 2-1 b. Adjusted gross income $50,000 Less: Itemized deductions (8,200) Personal and dependency exemptions (3 X $3,050) (9,150) Taxable income $32,650 pp. 2-6 to 2-8, Figure 2-1, and Table 2-1

c. Adjusted gross income ($1,500 wages + $1,400 dividends) $2,900 Less: Standard deduction* (1,750) Additional standard deduction (1,150) Personal exemption** (-0-) Taxable income $ -0- *A dependent’s standard deduction is limited to the sum of earned income plus $250, ($1,500 +250).

**A dependent may not claim a personal exemption on his or her return.

pp. 2-9, 2-10, Tables 2-1 and 2-2, and Example 9

d. Adjusted gross income ($4,700 wages + $700 interest) $5,400 Less: Standard deduction* (4,750) Personal exemption** (-0-) Taxable income $ 650

*A dependent’s standard deduction is limited to the sum of earned income plus

$250, but cannot exceed the standard deduction allowed a single taxpayer ($4,750 for 2003).

**A dependent may not claim a personal exemption on his or her return.

pp. 2-9, 2-10, Table 2-1, and Example 11

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 (7,000) Personal and dependency exemptions (3 X $3,050) (9,150)

Taxable income $19,850 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 2004. pp. 2-5, 2-7, 2-8, 2-33, Figure 2-1, Exhibits 2-1 and 2-2, and Table 2-1 30. Salary $70,000

Prize 5,000 AGI $75,000 Itemized deductions ($4,800 + $3,600) (8,400) Personal and dependency exemptions (4 X $3,050) (12,200)

Taxable income $54,400 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 ($7,000).

pp. 2-6, 2-8, Figure 2-1, and Exhibits 2-1 to 2-3 31. a. $4,750. Although $4,600 (earned income) + $250 = $4,850, the amount allowed

cannot exceed that available in 2003 for single taxpayers. b. $3,450. $3,200 (earned income) + $250. c. $750. The greater of $750 or $400 (earned income) + $250. d. $850. The greater of $750 or $600 (earned income) + $250. e. $3,200. $1,800 (earned income) + $250 + $1,150 (additional standard deduction).

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

32. a. Two. Petula’s personal exemption plus a dependency exemption for the mother. Trent does not qualify as her dependent due to the gross income test.

b. Two. A personal exemption for Rhett and one for Penny. Normally, spouses

must file a joint return in order to claim two personal exemptions. An exception exists, however, if the spouse has no gross income and is not claimed as a dependent by another.

c. Two. A personal exemption for Liza and a dependency exemption for Zoe. A

cousin does not meet the relationship test, but Zoe is a member of Liza’s household; Jerold is not.

d. Four. Personal exemptions for Kurt and Nadia and dependency exemptions for

Rosalyn and Hector. Although the children appear not to qualify under the gross income test, Rosalyn comes under the age exception (under age 19) and Hector comes under the student exception.


pp. 2-10 to 2-14 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. 2-14 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. Four. One personal exemption and three dependency exemptions (the ex-wife

and her parents). In-laws meet the relationship test, even if a divorce has taken place. An ex-spouse can qualify as a dependent in other than the year of divorce.

c. 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).

d. 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. 2-10 to 2-14

35. Exemption amount (9 X $3,050) $27,450

Step 1: AGI $225,000 Phase-out threshold (209,250) Excess amount $ 15,750 Step 2: $15,750 ÷ $2,500 = 7 (rounded up) X 2 = 14% (phase-out percentage) Step 3: Less: $27,450 X 14% (3,843)

Step 4: Deduction for personal and dependency exemptions $23,607 pp. 2-15 and 2-16 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 $3,050) 6,100 Dependency exemptions (3 X $3,050) 9,150 (26,750) Taxable income $67,350 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. 2-4 to 2-6, 2-8, 2-14, Example 34, Exhibits 2-1 and 2-2, and Figure 2-1 37. a. Wages $2,100

Bank interest 950 Bond interest (City of Chicago bond interest is tax-exempt) -0- Dividends 200 Gross income $3,250 Less: Standard deduction* (2,350) Personal exemption** (-0-) Taxable income $ 900

b. Bank interest $ 950

Bond interest -0- Dividend 200 Total unearned income $1,150 Minus: $750 + $750 standard deduction (1,500) 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 $750 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 $1,500, his tax is determined without

using his parents’ rate. Thus, Bob’s 2003 tax liability is $90 ($900 taxable income X 10%).

pp. 2-9, 2-10, 2-20 to 2-22, Exhibits 2-1 and 2-2, 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 $3,050. They both can be claimed as dependents by Walter and Nancy. Example 42

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 $3,050). She does not qualify under the student exception and is not under 19 years of age. Example 41

39. If Don kept the duplex, the annual tax thereon would generate an income tax liability of

$3,500 (35% 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 a $750 standard deduction and would have taxable

income of $9,250 ($10,000 – $750 standard deduction), which would be taxed at his own rate because he is not under 14 years of age.

(2) Sam would pay $1,088 tax on the $9,250 taxable income [($6,000 X 10%) +

($3,250 X 15%)]. The tax saving to the family unit in 2003 if Don transfers the duplex would be $2,412 ($3,500 – $1,088), 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. 2-9 and 2-18

40. a. Gross income $70,000

Long-term capital loss (3,000) AGI $67,000 Personal and dependency exemptions (3 X $3,050) (9,150) Itemized deductions (10,500) Taxable income $47,350

Tax on $47,350 using head of household rate schedule: $5,207.50 + 27%($47,350 – $38,050) = $7,719 (rounded).

Only $3,000 of the $4,000 capital loss is allowed. The $1,000 excess is carried over to 2004. The uncle qualifies as a dependent under the contiguous country (Canada or Mexico) exception to the citizen or residence test. The roommate satisfies the member of the household test.

b. Gross income $74,000

IRA contribution (3,000) AGI $71,000 Personal and dependency exemptions (3 X $3,050) (9,150) Standard deduction (head of household) (7,000)

Taxable income $54,850

Tax on $54,850 using head of household rate schedule: $5,207.50 + 27%($54,850 – $38,050) = $9,744 (rounded).

Cliff does not qualify as surviving spouse because he does not have a “child” as a

member of his household. Although a cousin does not meet the relationship test, he is a member of taxpayer’s household and can be claimed as a dependent.

c. Pension income $32,000

Dividend and bank interest income 12,000 AGI $44,000 Personal and dependency exemptions (4 X $3,050) (12,200) Standard deduction [($7,950) + additional standard deduction (2 X $950)] (9,850)


Tax on $21,950 using married filing jointly rate schedule: $1,200 + 15%($21,950 – $12,000) = $2,693 (rounded).

The interest of $24,000 from state and local bonds is a nontaxable exclusion.

Florence and Jeri satisfy the relationship test and do not have to be part of the household. As a “child” under the age of 19, Jeri does not need to meet the gross income test.

pp. 2-6, 2-8, 2-13, 2-14, 2-18, 2-27, 2-28, Example 24, Figure 2-1, Tables 2-1, 2-2, and

Appendix A


41. Salary income ($49,000 + $50,000) $ 99,000 Interest income ($900 + $1,300) 2,200 Dividend income ($400 + $600) 1,000 AGI $102,200 Personal and dependency exemptions (5 X $3,050) (15,250) Itemized deductions (13,600) Taxable income $ 73,350 Tax on $73,350 using married filing jointly rate schedule: $6,517.50 + 27%($73,350 – $47,450) = $13,511 (rounded).

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. 2-13, 2-14, Example 24, and Exhibits 2-1 and 2-2 42. Unearned income $1,800

Minus: $750 base amount + $750 standard deduction (1,500) Unearned income taxed at parents’ rate $ 300

Ginni’s parents are in the 27% bracket, so her unearned income would generate $81 of tax (27% X $300). 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 $750 or $2,100 (earned income) + $250] (2,350) Taxable income $1,550 Less: Unearned income taxed at parents’ rate (300) Income taxed at Ginni’s rate $1,250 Ginni’s tax rate X 10%

Tax at Ginni’s rate $ 125

Ginni’s total tax: $81 (unearned income taxed at parents’ rate) + $125 (taxed at Ginni’s rate) = $206.

pp. 2-20 to 2-22 and Example 28 43. Unearned income (dividends and interest) $11,100

Base amount not taxed at parents’ rate (750) Standard deduction (750) Unearned income taxed at parents’ rate $ 9,600

Nash’s parents cannot make the parental election. pp. 2-20 to 2-22 and Example 28


44. Willis, Hoffman, Maloney, and Raabe, CPAs 5191 Natorp Boulevard Mason, OH 45040

September 11, 2003 Ms. Wanda Brown 4339 Elm St., Apt. 39A Cincinnati, OH 45221 Dear Wanda:

At my last meeting with you and Bruce, we discussed the so-called marriage penalty. Unfair as it may seem, our tax law sometimes causes married taxpayers to pay more income tax than would have been the case if they had remained single. As you requested, I have determined what, if any, marriage penalty would result if you and Bruce marry in 2003. Schedule 1 shows your approximate tax liabilities for 2003 if the marriage is delayed to January of 2004. Schedule 2 gives the result of a December marriage. As you can see, postponing the marriage to 2004 saves combined income taxes of $1,670 [$25,952 (Schedule 2) – $24,282 (Schedule 1)]. If I can be of further service to you and Bruce, please feel free to contact me. Sincerely, John Allen, CPA Partner Enclosure

Schedule 1

Marriage Delayed to 2004 Income Tax Computation Based on Single Status

Bruce Wanda Adjusted gross income $65,000 $68,000 Less standard deduction (4,750) (4,750) Less personal exemption (3,050) (3,050) Taxable income $57,200 $60,200 Tax from Rate Schedule X $11,736 $12,546 Total tax: $11,736 + $12,546 $24,282


Schedule 2 Marriage in 2003

Income Tax Computation Based on Married Status Adjusted gross income ($65,000 + $68,000) $133,000 Less standard deduction (7,950) Less personal exemptions (2 X $3,050) (6,100) Taxable income $118,950 Tax from Rate Schedule Y-1 $ 25,952

p. 2-28 and Example 30 45. a. Sam and Lana need not file since their gross income of $14,500 is less than the

$15,950 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 $4,750 (his standard deduction).

c. Mike is not required to file since his gross income of $8,600 is not more than the

$8,950 filing requirement. d. Marge is required to file. Her has gross income is less than $7,800, but her net

earnings from self-employment are more than $400. Taxpayers in a., b., and c. should file, even if a return is not required, to obtain a

refund if any income tax was withheld. pp. 2-23, 2-24, and Table 2-4

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 $4,750. b. Anita must file a tax return since she is claimed on her parents’ return and has

unearned income greater than $750. 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 $1,500.

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 $750 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 $4,000 [$2,850 (the greater of $750 or the sum of earned income + $250) + $1,150 (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. 2-23 and 2-24


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. 2-27 to 2-30 and Examples 31 to 33 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. 2-27 to 2-30 and Examples 31 and 33

49. In 2001, Sue is eligible to use the married, filing jointly status. Henry’s executor must

consent to filing a joint return. In 2002, 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 2003, Mike became a part-time student and earned over $3,000; therefore, his mother

cannot claim him as a dependent. Sue’s filing status is a head of household for 2003. pp. 2-14, 2-26, 2-28, 2-29, and Examples 31 and 32 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 $3,050. Therefore, Tracy can claim only one exemption. pp. 2-14, 2-29, and Example 32

51. a. Tax on short-term capital gain (30% X $4,000) $1,200 Tax on long term capital gains of $2,000 + $5,000 (20% X $7,000) 1,400 Total tax $2,600

The long-term loss of $3,000 on the sale of the powerboat is a nondeductible personal loss.


b. Tax on short-term capital gain (15% X $4,000) $ 600 Tax on long-term capital gain (10% X $7,000) 700 Total tax $1,300 pp. 2-30 to 2-33 and Examples 34 to 38 52. a. The loss on the Pigeon Corporation stock of $4,000 is first applied to the gain on

the painting of $5,000. The painting is a collectible taxed at a 28% rate. After this combination, the end result is:

Tax on remaining collectible gain (28% X $1,000) $280 Tax on land gain (20% X $3,000) 600 Total tax on all gains $880 b. Use the same netting procedure, then tax the net collectible gain at 15% and the

land gain at 10%. Thus, $150 (15% X $1,000) + $300 (10% X $3,000) = $450.

pp. 2-30 to 2-33 and Example 38

53. Yes. If Gina prepays the 2003 contribution of $2,400 in 2002, her 2002 itemized deductions will be $6,300, her taxable income will be $46,700 ($56,000 – $6,300 – $3,000), and her tax will be $8,962*. She will use the standard deduction of $4,750 in 2003, which will result in taxable income of $52,200 ($60,000 – $4,750 – $3,050) and her tax will be $10,386**. This will yield total deductions of $11,050 ($6,300 + $4,750) as opposed to $9,450 ($4,700 + $4,750). The difference is $1,600, which saves $432 in Gina’s marginal tax bracket of 27%. p. 2-33

*Based on 2002 Tax Table **Based on 2003 Tax Rate Schedules. CUMULATIVE PROBLEMS 54. Salaries ($43,000 + $41,000) (Note 1) $84,000

Interest income— CD issued by bank (Note 2) $ 800 John Clay loan (Note 3) 600 1,400 Dividends 300 Property transactions (Note 4) 3,400 Jury duty fees (Note 5) 420 AGI $89,520 Itemized deductions (Note 6) Interest on home mortgage $4,800 Property taxes 3,600 Charitable contributions 2,400 (10,800) Exemptions (Note 7)— Personal (2 X $3,050) $6,100 Dependency (3 X $3,050) (Note 8) 9,150 (15,250)



Notes

(1) Exclusions include the $22,000 gift and the life insurance proceeds of $50,000. (2) The $350 of interest from the Tampa bonds is an exclusion.

(3) Of the $10,600 received from John Clay, $10,000 is a return of capital

(nontaxable) and $600 is interest (taxable). (4) The $5,000 loss ($16,000 – $11,000) on the RV camper cannot be deducted as it

is a personal loss. The $3,400 gain [$4,000 (selling price) – $600 (basis of $300 + $300)] on the bass boat is taxed as a long-term capital gain.

(5) Despite what the jury foreman believes, jury duty fees are included in gross

income.

(6) The Clay’s itemized deductions of $10,800 exceed the $7,950 standard deduction allowed married persons for 2003.

(7) As the Clays contribute more than half of Dale’s support, a multiple support

agreement is not necessary.

(8) Although both Trudy and Lydia appear to violate the gross income rule, they come under the “child” exceptions. Trudy is a full-time student under age 24, and Lydia is under age 19.

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) (6,900) Personal and dependency exemptions ($3,000 X 2) (6,000) Taxable income $57,800 Tax on taxable income (see Tax Tables) head of household $10,619 Less amounts withheld and paid in ($10,900 + $1,200) (12,100) Net tax payable (or refund due) for 2002 ($ 1,481) Note 1: The standard deduction of $6,900 for a head of household is greater than the

itemized deductions of $6,400. See the tax return solution beginning on page 2-20 of the Solutions Manual.


Part II. Tax Planning Willis, Hoffman, Maloney, and Raabe, CPAs 5191 Natorp Boulevard Mason, OH 45040

February 26, 2003 Mr. Horace Fern 321 Grant Avenue Cheyenne, WY 82002

Dear Horace: I am enclosing your completed tax return for 2002. Please sign on page 2 of Form 1040 and use the enclosed envelope for mailing the return to the IRS by April 15, 2003. Regarding your tax position for 2003, 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: 2002 taxable income $57,800 Taxable income for 2003 will increase because of: Increase in income for 2003 (salary) 6,200 Decrease in deductions: Exemption for mother claimed in 2002 3,000 Alimony paid to ex-wife 3,300 Itemized deductions of $6,400 in 2003 (standard deduction is less) versus standard deduction in 2002 of $6,900 500 Taxable income for 2003 will decrease because of: Increase in exemption amount for 2003 (50) Projected taxable income for 2003 $70,750 Tax on projected 2003 taxable income (single): $14,868 + 30%($70,750 – $68,800) $15,453 Less: 2002 tax (10,619) Increase in tax $ 4,834 One item that is aggravating your tax burden is the interest income from the CDs. In this regard, you might consider investing in state or local bonds that yield tax-free income. Another possibility would be to invest in stocks that generate low yield but possess high growth potential. If I can be of further assistance to you, please call me. Sincerely, Jane Welsch, CPA Partner Enclosure


55.


55. continued


55. continued

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