Posted: October 20th, 2022

TAX-Ch06 DISCUSSION QUESTIONS LO.1 “All income must be reported, and all deductions are allowed unless specifically…

Ch06 DISCUSSION QUESTIONS1. LO.1 “All income must be reported, and all deductions are allowed unless specifically disallowed in the Code.” Discuss.2. LO.1 Aaron has AGI of $85,000 and deductions of $9,500. Does it matter to Aaron whether the deductions are for or from AGI? Why or why not?3. LO.1 Michael earned $10,000 at the K-M Resort Golf Club during the summer prior to his senior year in college. He wants to make a contribution to a traditional IRA, but the amount is dependent on whether it reduces his taxable income. If Michael is going to claim the standard deduction, how much should he contribute to a traditional IRA?4. LO.1 Classify each of the following expenditures as a deduction for AGI, a deduction from AGI, or not deductible:a. Sam gives $5,000 to his father as a birthday gift.b. Sandra gives $1,000 to her church.c. Albert pays Dr. Dafashy $500 for medical services rendered.d. Mia pays alimony of $12,000 to Bill.e. Rex, who is self-employed, contributes $1,000 to his pension plan.f. April pays expenses of $500 associated with her rental property.5. LO.1 Classify each of the following expenditures as a deduction for AGI, a deduction from AGI, or not deductible:a. Amos contributes to his H.R. 10 plan (i.e., a retirement plan for a self-employed individual).b. Keith pays child support to his former wife, Renee, for the support of their son, Chris.c. Judy pays for professional dues that are reimbursed by her employer.d. Ted pays $500 as the monthly mortgage payment on his personal residence. Of this amount, $100 represents a payment on principal, and $400 represents an interest payment.e. Lynn pays a moving company for moving her household goods to Detroit, where she is starting a new job. She is not reimbursed by her employer.f. Ralph pays property taxes on his personal residence.6. LO.1 Larry and Susan each invest $10,000 in separate investment activities. They each incur deductible expenses of $800 associated with their respective investments. Explain why Larry’s expenses might be properly classified as deductions from AGI (itemized deductions) and Susan’s expenses might be appropriately classified as deductions for AGI.7. LO.1 Nanette is a first-grade teacher. Potential deductions are charitable contributions of $800, personal property taxes on her car of $240, and various supplies purchased for use in her classroom of $225 (none reimbursed by her school). How will these items affect Nanette’s Federal income tax return?8. LO.1 List three items that § 162 specifically excludes from classification as a trade or business expense.9. LO.1 In the determination of whether a business expense is deductible, the reasonableness requirement applies only to salaries. Evaluate this statement.10. LO.1 Dave uses the second floor of a building for his residence and the first floor for his business. The uninsured building is destroyed by fire. Are the tax consequences the same for each part of the building? Explain.11. LO.1 Mary Kate owns a building that she leases to an individual who operates a grocery store. Rent income is $10,000, and rental expenses are $6,000. On what Form 1040 schedule or schedules are the income and expenses reported?12. LO.2 What is the “actually paid” requirement for the deduction of an expense by a cash basis taxpayer? Does actual payment ensure a deduction? Explain.13. LO.2 Aubry, a cash basis and calendar year taxpayer, decides to reduce his taxable income for 2013 by buying $65,000 worth of supplies for his business on December 27,2013. The supplies will be used up in 2014.a. Can Aubry deduct the expenditure for 2013?b. Would your answer in part (a) change if Aubry bought the supplies because the seller was going out of business and offered a large discount on the price? Explain.14. LO.2 What is the significance of the all events and economic performance tests?15. LO.2 Why is the reserve method not allowed to be used for Federal income tax purposes?16. LO.3 Clear, Inc., is a bottled water distributor. Clear’s delivery trucks frequently are required to park in no-parking zones to make their deliveries. If the trucks are occasionally ticketed, can Clear deduct the fines that it pays? Explain.17. LO.3 Ted, an agent for an airline manufacturer, is negotiating a sale with a representative of the U.S. government and with a representative of a developing country. Ted’s company has sufficient capacity to handle only one of the orders. Both orders will have the same contract price. Ted believes that if his employer authorizes a $500,000 payment to the representative of the foreign country, he can guarantee the sale. He is not sure that he can obtain the same result with the U.S. government. Identify the relevant tax issues for Ted.18. LO.3 Stuart, an insurance salesperson, is arrested for allegedly robbing a convenience store. He hires an attorney who is successful in getting the charges dropped. Is the attorney’s fee deductible? Explain.19. LO.3 Linda operates a drug-running operation. Which of the following expenses that she incurs can reduce taxable income?a. Bribes paid to border guards.b. Salaries to employees.c. Price paid for drugs purchased for resale.d. Kickbacks to police.e. Rent on an office.f. Depreciation on office furniture and equipment.g. Tenant’s casualty insurance.h. Utilities.20. LO.3 Gordon anticipates that being positively perceived by the individual who is elected mayor will be beneficial for his business. Therefore, he contributes to the campaigns of both the Democratic and the Republican candidates. The Republican candidate is elected mayor. Can Gordon deduct any of the political contributions he made?21. LO.3 Melissa, the owner of a sole proprietorship, does not provide health insurance for her 20 employees. She plans to spend $1,500 lobbying in opposition to legislation that would require her to provide such insurance. Discuss the tax advantages and disadvantages of paying the $1,500 to a professional lobbyist rather than spending the $1,500 on in-house lobbying expenditures.22. LO.3 What limits exist on the deductibility of executive compensation? Do the limits apply to all types of business entities? Are there any exceptions to the limitations?Explain.23. LO.3 Paul operates a restaurant in Cleveland. He travels to Columbus to investigate acquiring a business. He incurs expenses as follows: $1,500 for travel, $2,000 for legal advice, and $3,500 for a market analysis. Based on the different tax consequences listed below, describe the circumstances that were involved in Paul’s investigation of the business.a. Paul deducts the $7,000 of expenses.b. Paul cannot deduct any of the $7,000 of expenses.c. Paul deducts $5,000 of the expenses and amortizes the $2,000 balance over a period of 180 months.24. LO.3 Harold conducts a business with the following results for the year:Revenue $20,000Depreciation on car 3,960Operating expenses of car 3,100Rent 6,000Wages 8,200Amortization of intangibles 680Harold estimates that due to a depressed real estate market, the value of land owned by the business declined by $5,200.a. Calculate the effect of Harold’s business on his AGI.b. How would your answer in part (a) change if the activity was a hobby?25. LO.3 Sarah owns a vacation cabin in the Tennessee mountains. Without considering the cabin, she has gross income of $65,000. During the year, she rents the cabin for two weeks for $2,500 and uses it herself for four weeks. The total expenses for the year are $10,000 mortgage interest; $1,500 property tax; $2,000 utilities, insurance, and maintenance; and $3,200 depreciation.a. What effect does the rental of the vacation cabin have on Sarah’s AGI?b. What expenses can Sarah deduct, and how are they classified (i.e., for or from AGI)?26. LO.3 Under what circumstances may a taxpayer deduct a rental loss associated with a vacation home?27. LO.3 Karen and Andy own a beach house. They have an agreement with a rental agent to rent it up to 200 days per year. For the past three years, the agent has been successful in renting it for 200 days. Karen and Andy use the beach house for one week during the summer and one week during Thanksgiving. Their daughter, Sarah, a college student, has asked if she and some friends can use the beach house for the week of spring break.Advise Karen and Andy how they should respond, and identify any relevant tax issues.28. LO.3 Hank was transferred from Phoenix to North Dakota on March 1 of the current year. He immediately put his home in Phoenix up for rent. The home was rented May 1 to November 30 and was vacant during the month of December. It was rented again onJanuary 1 for six months. What expenses, if any, can Hank deduct on his return? Which deductions are for AGI, and which ones are from AGI?29. LO.3 Ray loses his job as a result of a corporate downsizing. Consequently, he falls behind on the mortgage payments on his personal residence. His friend Ted would like to make the delinquent mortgage payments for him.a. Could the payments be structured so that Ray can deduct the mortgage interest?b. Could the payment arrangement deny both Ray and Ted amortgage interest deduction?c. Could the payments be structured so that Ted can deduct the mortgage interest?30. LO.3 Edna incurs various legal fees in obtaining a divorce. Which types of expenses associated with the divorce are deductible by Edna, and which are not?31. LO.3 Ella owns 60% of the stock of Peach, Inc. The stock has declined in value since she purchased it five years ago. She is going to sell 5% of the stock to a relative. Ella is also going to make a gift of 10% of the stock to another relative. Identify the relevant tax issues for Ella.32. LO.3 Jarret owns City of Charleston bonds with an adjusted basis of $190,000. During the year, he receives interest payments of $3,800. Jarret partially financed the purchase of the bonds by borrowing $100,000 at 5% interest. Jarret’s interest payments on the loan this year are $4,900, and his principal payments are $1,100.a. Should Jarret report any interest income this year? Explain.b. Can Jarret deduct any interest expense this year? Explain.33. LO.1 Amos is a self-employed tax attorney. He and Monica, his employee, attend a conference in Dallas sponsored by the American Institute of CPAs. The following expenses are incurred during the trip:Amos MonicaConference registration $ 900 $900Airfare 1,200 700Taxi fares 100 –0–Lodging in Dallas 750 300a. Amos pays for all of these expenses. Calculate the effect of these expenses on Amos’sAGI.b. Would your answer to part (a) change if the American Bar Association had sponsored the conference? Explain.34. LO.1 Daniel, age 38, is single and has the following income and expenses in 2013:Salary income $60,000Net rent income 6,000Dividend income 3,500Payment of alimony 12,000Mortgage interest on residence 4,900Property tax on residence 1,200Contribution to traditional IRA 5,000Contribution to United Church 2,100Loss on the sale of real estate (held for investment) 2,000Medical expenses 3,250State income tax 300Federal income tax 7,000a. Calculate Daniel’s AGI.b. Should Daniel itemize his deductions from AGI or take the standard deduction?35. LO.1 Janice, age 22, is a student who earns $10,000 working part-time at the college ice cream shop in 2013. She has no other income. Her medical expenses for the year total $3,000. During the year, she suffers a casualty loss of $3,500 when her apartment catches on fire. Janice contributes $1,000 to her church. On the advice of her parents, Janice is trying to decide whether to contribute $1,000 to the traditional IRA her parents set up for her. What effect would the IRA contribution have on Janice’s itemized deductions?36. LO.1 Kirby and his wife Melinda own all of the stock of Thrush. Melinda is the president, and Kirby is the vice president. Melinda and Kirby are paid salaries of $500,000 and $350,000, respectively, each year. They consider the salaries to be reasonable based on a comparison of salaries paid for comparable positions in comparable companies.They project Thrush’s taxable income for next year, before their salaries, to be $975,000. They decide to place their three teenage children on the payroll and to pay them total salaries of $125,000. The children will each work about five hours per week for Thrush.a. What are Kirby and Melinda trying to achieve by hiring the children?b. Calculate the tax consequences on Thrush and on Kirby and Melinda’s family of hiring the children.37. LO.1 A list of the items that Peggy sold and the losses she incurred during the current tax year is as follows:Yellow, Inc. stock $ 1,600Peggy’s personal use SUV 8,000Peggy’s personal residence 10,000City of Newburyport bonds 900She also had a theft loss of $1,500 on her uninsured business use car. Calculate Peggy’s deductible losses.38. LO.2 Falcon, Inc., paid salaries of $500,000 to its employees during its first year of operations.At the end of the year, Falcon had unpaid salaries of $45,000.a. Calculate the salary deduction if Falcon is a cash basis taxpayer.b. Calculate the salary deduction if Falcon is an accrual basis taxpayer.39. LO.2 Maud, a calendar year taxpayer, is the owner of a sole proprietorship that uses the cash method. On February 1, 2013, she leases an office building to use in her business for $120,000 for an 18-month period. To obtain this favorable lease rate, she pays the $120,000 at the inception of the lease. How much rent expense may Maud deduct on her 2013 tax return?40. LO.2 Duck, an accrual basis corporation, sponsored a rock concert on December 29,2013. Gross receipts were $300,000. The following expenses were incurred and paid as indicated:Expense Payment DateRental of coliseum $ 25,000 December 21, 2013Cost of goods sold:Food 30,000 December 30, 2013Souvenirs 60,000 December 30, 2013Performers 100,000 January 5, 2014Cleaning of coliseum 10,000 February 1, 2014Because the coliseum was not scheduled to be used again until January 15, the company with which Duck had contracted did not perform the cleanup until January 8–10,2014.Calculate Duck’s net income from the concert for tax purposes for 2013.41. LO.3 Doug incurred and paid the following expenses during the year:• $50 for a ticket for running a red light while he was commuting to work.• $100 for a ticket for parking in a handicapped parking space.• $200 to an attorney to represent him in traffic court as to the two tickets.• $500 to an attorney to draft an agreement with a tenant for a one-year lease on an apartment that Doug owns.• $1,000 to an attorney to negotiate a reduction in his child support payments.• $2,500 to an attorney to negotiate a reduction in his qualified alimony payments to a former spouse.Calculate the amount of Doug’s deductible expenses.42. LO.3 Trevor, a friend of yours from high school, works as a server at the ST Café. He asks you to help him prepare his Federal income tax return. When you inquire about why his bank deposits substantially exceed his tip income, he confides to you that he is a bookie on the side. Trevor then provides you with the following documented income and expenses for the year:Tip income $16,000Gambling income 52,000Gambling expensesPayouts to winners 29,000Employee compensation 8,000Bribe to police officer who is aware ofTrevor’s bookie activity 7,500a. How will these items affect Trevor’s AGI?b. His taxable income?c. If Trevor’s business was an illegal drug operation and the cost of the illegal drugs sold was $6,200, how would your answers to parts (a) and (b) differ?43. LO.3 Polly made political contributions to the following:National Republican Party $1,000National Democratic Party 1,000Candidate for mayor 700Candidate for state senate 200Candidate for school board 250How much, if any, can Polly deduct?44. LO.3, 4 Amber, a publicly held corporation (not a TARP recipient), currently pays its president an annual salary of $900,000. In addition, it contributes $20,000 annually to a defined contribution pension plan for him. As a means of increasing company profitability, the board of directors decides to increase the president’s compensation. Two proposals are being considered. Under the first proposal, the salary and pension contribution for the president would be increased by 30%. Under the second proposal,Amber would implement a performance-based compensation program that is projected to provide about the same amount of additional compensation and pension contribution for the president.a. Evaluate the alternatives from the perspective of Amber, Inc.b. Prepare a letter to Amber’s board of directors that contains your recommendations.Address the letter to the board chairperson, Agnes Riddle, whose address is 100James Tower, Cleveland, OH 44106.45. LO.3 Vermillion, Inc., a publicly held corporation (not a TARP recipient), pays the following salaries to its executives:Salary Bonus Retirement Plan ContributionCEO $2,000,000 $100,000 $80,000Executive vice president 1,800,000 90,000 72,000Treasurer 1,600,000 –0– 64,000Marketing vice president 1,500,000 75,000 60,000Operations vice president 1,400,000 70,000 56,000Distribution vice president 1,200,000 60,000 48,000Research vice president 1,100,000 –0– 44,000Controller 800,000 –0– 32,000Vermillion normally does not pay bonuses, but after reviewing the results of operations for the year, the board of directors decided to pay a 5% bonus to selected executives.What is the amount of these payments that Vermillion may deduct?46. LO.3 Nancy, the owner of a very successful hotel chain in the Southeast, is exploring the possibility of expanding the chain into a city in the Northeast. She incurs $35,000 of expenses associated with this investigation. Based on the regulatory environment for hotels in the city, she decides not to expand. During the year, she also investigates opening a restaurant that will be part of a national restaurant chain. Her expenses for this are $53,000. The restaurant begins operations on September 1. Determine the amount that Nancy can deduct in the current year for investigating these two businesses.47. LO.3 Terry traveled to a neighboring state to investigate the purchase of two hardware stores. His expenses included travel, legal, accounting, and miscellaneous expenses. The total was $52,000. He incurred the expenses in June and July 2013. Under the following circumstances, what can Terry deduct in 2013?a. Terry was in the hardware store business and did not acquire the two hardware stores.b. Terry was in the hardware store business and acquired the two hardware stores and began operating them on October 1, 2013.c. Terry did not acquire the two hardware stores and was not in the hardware store business.d. Terry acquired the two hardware stores but was not in the hardware store business when he acquired them. Operations began on October 1, 2013.48. LO.3 Alex, who is single, conducts an activity that is appropriately classified as a hobby.The activity produces the following revenues and expenses:Revenue $18,000Property taxes 3,000Materials and supplies 4,500Utilities 2,000Advertising 5,000Insurance 750Depreciation 4,000Without regard to this activity, Alex’s AGI is $42,000. Determine the amount of incomeAlex must report, the amount of the expenses he is permitted to deduct, and his taxable income.49. LO.3 Samantha, an executive, has AGI of $100,000 before considering income or loss from her miniature horse business. Her outside income comes from prizes for winning horse shows, stud fees, and sales of yearlings. Samantha’s home is on 20 acres, half of which she uses for the horse activity (i.e., stables, paddocks, fences, tack houses, and other related improvements).Samantha’s office in her home is 10% of the square footage of the house. She uses the office exclusively for maintaining files and records on the horse activities. Her books show the following income and expenses for the current year:Income from fees, prizes, and sales $22,000ExpensesEntry fees 1,000Feed and veterinary bills 4,000Supplies 900Publications and dues 500Travel to horse shows (no meals) 2,300Salaries and wages of employees 8,000Depreciation—Horse equipment $3,000Horse farm improvements 7,000On 10% of personal residence 1,000 11,000Total home mortgage interest 24,000Total property taxes on home 2,200Total property taxes on horse farm improvements 800The mortgage interest is only on her home because the horse farm improvements are not mortgaged.a. What are Samantha’s tax consequences if the miniature horse activity is a hobby?b. If it is a business?50. LO.3 Adelene, who lives in a winter resort area, rented her personal residence for 14 days while she was visiting Brussels. Rent income was $5,000. Related expenses for the year were as follows:Real property taxes $ 3,800Mortgage interest 7,500Utilities 3,700Insurance 2,500Repairs 2,100Depreciation 15,000Determine the effect on Adelene’s AGI.51. LO.3 During the year (not a leap year), Anna rented her vacation home for 30 days, used it personally for 20 days, and left it vacant for 315 days. She had the following income and expenses:Rent income $ 7,000ExpensesReal estate taxes 2,500Interest on mortgage 9,000Utilities 2,400Repairs 1,000Roof replacement (a capital expenditure) 12,000Depreciation 7,500a. Compute Anna’s net rent income or loss and the amounts she can itemize on her tax return, using the court’s approach to allocating property taxes and interest.b. How would your answer in part (a) differ using the IRS’s method of allocating property taxes and interest?52. LO.3 How would your answer to Problem 51 differ if Anna had rented the house for 87 days and had used it personally for 13 days?53. LO.1, 3 Chee, single, age 40, had the following income and expenses during the year (not a leap year):IncomeSalary $43,000Rental of vacation home (rented 60 days, used personally 60 days, vacant 245 days) 4,000Municipal bond interest 2,000Dividend from General Electric 400ExpensesInterest on home mortgage 8,400Interest on vacation home 4,758Interest on loan used to buy municipal bonds 3,100Property tax on home 2,200Property tax on vacation home 1,098State income tax 3,300State sales tax 900Charitable contributions 1,100Tax return preparation fee 300Utilities and maintenance on vacation home 2,600Depreciation on rental 50% of vacation home 3,500Calculate Chee’s taxable income for the year before personal exemptions.54. LO.1, 3, 4 Elisa and Clyde operate a retail sports memorabilia shop. For the current year, sales revenue is $55,000 and expenses are as follows:Cost of goods sold $21,000Advertising 1,000Utilities 2,000Rent 4,500Insurance 1,500Wages to Boyd 8,000Elisa and Clyde pay $8,000 in wages to Boyd, a part-time employee. Because this amount is $1,000 below the minimum wage, Boyd threatens to file a complaint with the appropriateFederal agency. Although Elisa and Clyde pay no attention to Boyd’s threat, Chelsie (Elisa’s mother) gives Boyd a check for $1,000 for the disputed wages. Both Elisa andClyde ridicule Chelsie for wasting money when they learn what she has done. The retail shop is the only source of income for Elisa and Clyde.a. Calculate Elisa and Clyde’s AGI.b. Can Chelsie deduct the $1,000 payment on her tax return? Explain.c. How could the tax position of the parties be improved?55. LO.3, 4 Jay’s sole proprietorship has the following assets:Basis Fair Market ValueCash $ 10,000 $ 10,000Accounts receivable 18,000 18,000Inventory 25,000 30,000Patent 22,000 40,000Land 50,000 75,000 $125,000 $173,000The building in which Jay’s business is located is leased. The lease expires at the end of the year.Jay is 70 years old and would like to retire. He expects to be in the 35% tax bracket.Jay is negotiating the sale of the business with Lois, a key employee. They have agreed on the fair market value of the assets, as indicated previously, and agree that the total purchase price should be about $200,000.a. Advise Jay regarding how the sale should be structured.b. Advise Lois regarding how the purchase should be structured.c. What might they do to achieve an acceptable compromise?56. LO.3 Brittany Callihan sold stock (basis of $184,000) to her son, Ridge, for $160,000, the fair market value.a. What are the tax consequences to Brittany?b. What are the tax consequences to Ridge if he later sells the stock for $190,000? For $152,000? For $174,000?c. Write a letter to Brittany in which you inform her of the tax consequences if she sells the stock to Ridge for $160,000. Explain how a sales transaction could be structured that would produce better tax consequences for her. Brittany’s address is 32 CountryLane, Lawrence, KS 66045.57. LO.3 The Robin Corporation is owned as follows:Isabelle 26%Peter, Isabelle’s husband 19%Sonya, Isabelle’s mother 15%Reggie, Isabelle’s father 25%Quinn, an unrelated party 15%Robin is on the accrual basis, and Isabelle and Peter are on the cash basis. Isabelle and Peter each loaned the Robin Corporation $40,000 out of their separate funds. OnDecember 31, 2013, Robin accrued interest at 7% on both loans. The interest was paid on February 4, 2014. What is the tax treatment of this interest expense/income to Isabelle,Peter, and Robin?58. LO.3 For each of the following independent transactions, calculate the recognized gain or loss to the seller and the adjusted basis to the buyer.a. Bonnie sells Parchment, Inc. stock (adjusted basis $17,000) to Phillip, her brother, for its fair market value of $12,000.b. Amos sells land (adjusted basis $85,000) to his nephew, Boyd, for its fair market value of $70,000.c. Susan sells a tax-exempt bond (adjusted basis $20,000) to her wholly owned corporation for its fair market value of $19,000.d. Ron sells a business truck (adjusted basis $20,000) that he uses in his sole proprietorship to his cousin, Agnes, for its fair market value of $18,500.e. Martha sells her partnership interest (adjusted basis $175,000) in Pearl Partnership to her adult daughter, Kim, for $220,000.59. LO.3 Murphy has a brokerage account and buys on the margin, which resulted in an interest expense of $20,000 during the year. Income generated through the brokerage account was as follows:Municipal interest $ 50,000Taxable dividends and interest 350,000How much investment interest can Murphy deduct?60. LO.1, 3, 4 During the current year, Robert pays the following amounts associated with his own residence and that of his daughter, Anne:Property taxes:On home owned by Robert $3,000On home owned by Anne 1,500Mortgage interest:Associated with Robert’s home 8,000Associated with Anne’s home 4,500Repairs to:Robert’s home 1,200Anne’s home 700Utilities:Robert’s home 2,700Anne’s home 1,600Replacement of roof:Robert’s home 4,000a. Which of these expenses can Robert deduct?b. Which of these expenses can Anne deduct?c. Are the deductions for AGI or from AGI (itemized)?d. How could the tax consequences be improved?

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