*A dependent's standard deduction is limited to the sum of his or her earned income plus $250, not to exceed the basic standard deduction

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

*A dependent's standard deduction is limited to the sum of his or her earned income plus $250. Matt would elect the standard deduction because it exceeds his itemized deductions of $800.

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

4. a. $1,050. The greater of $700 or the sum of earned income of $800 plus $250.

b. $4,250. The greater of $700 or the sum of earned income of $4,300 plus $250 (but not to exceed the standard deduction of $4,250).

c. $2,350. The greater of $700 or the sum of earned income of $1,050 plus $250 + $1,050 (additional standard deduction for over 65).

d. $2,800. The greater of $700 or the sum of earned income of $0 plus $250 + $2,100 (additional standard deduction for a dependent who is both over 65 and blind).

p. 15-8 and Examples 8 to 11

5. a. Two. Personal exemptions for Warren and Terri and no dependency exemptions for Demi and Paul. Demi is subject to the gross income test because she is not under age 19. Paul also does not meet the gross income test.

b. Two. One personal exemption for Hortense and a dependency exemption for her father. The father passes the gross income test since only the taxable portion of his income ($2,400 interest on a savings account) is considered.

c. Three. Personal exemptions for Dennis and Ava and a dependency exemption for Henry. The son is subject to the gross income test since he is not under age 24 although he is a full-time student. However, his gross income is only $2,500.

d. Two. One personal exemption for Earl. Brad satisfies all of the tests for the dependency exemption, including the gross income test.

6. The first issue is whether Martha is a dependent of her son, Roland, or is self-supporting since she has the financial capacity to support herself. The second issue is whether it is appropriate for Martha to invest her assets in tax-exempt bonds so that the gross income test for dependency exemption purposes can be satisfied.

There is nothing improper in the procedure followed by Roland and Martha. Martha does not fail the support test on Roland's return because Roland furnishes her support. The fact that she could have supported herself does not matter. As illustrated in Example 14 in the text, Martha does not choose to apply her funds on her own support.

Nor does Martha fail the gross income test because none of her income is taxable. Only income subject to taxation is considered as being included in gross income. Consequently, Roland may claim a dependency exemption for Martha.

Peter's parents are in the 28% bracket, so his unearned income would generate $84 of tax ($300 X 28%).

Computation of Peter's taxable income:

September 10, 1998

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 married in 1998. Schedule 1 shows your approximate tax liabilities for 1998 if the marriage is delayed to January of 1999. Schedule 2 gives the result of a December marriage. As you can see, postponing the marriage to 1999 saves combined income taxes of $2,023 [$28,781 (Schedule 2) - $26,758 (Schedule 1)].

If I can be of further service to you and Bruce, please feel free to contact me.

Sincerely,

John Allen, CPA

Schedule 1

Marriage Delayed to 1999

Income Tax Computation Based on Single Status

Schedule 2

Marriage in 1998

Income Tax Computation Based on Married Status

13. a. Bob need not file a tax return. He is claimed on his parents' return, but he has earned income only and gross income of less than the standard deduction of $4,250.

b. Anita must file a tax return since she is claimed on her parents' return and has unearned income greater than $700. 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 $1,400.

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 $700 or the sum of earned income plus $250.

d. Karen must file a tax return since she is claimed on her parents' return and has both earned plus unearned income and gross income of more than the larger of $700 or the sum of earned income plus $250.

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

p 15-21

14. a. Darlene qualifies as a surviving spouse.

b. Darlene qualifies as a surviving spouse for tax years 1995 and 1996. For 1998, however, she appears to qualify for head of household status.

c. Darlene qualifies for head of household status.

d. Darlene seems to satisfy the abandoned spouse rules. As such, she is treated as single and can claim head of household status.

p. 15-23

15. Yes. If Gina prepays the 1998 contribution of $2,400 in 1997, her 1997 itemized deductions will be $6,300, her taxable income will be $47,050 ($56,000 - $6,300 - $2,650), and her tax will be $9,977 from the 1997 Tax Table. She will use the standard deduction of $4,250 in 1998, which will result in taxable income of $53,050 ($60,000 - $4,250 - $2,700), and her tax will be $11,559*. This will give total deductions of $10,550 as opposed to $8,400 ($4,150 + $4,250).

*Based on tax rate schedules.

1. Child support payments ($3,600) are nontaxable. Proceeds from the garage sale ($1,180) result in a return of capital. Actually a capital loss of $2,820 ($4,000 - $1,180) resulted, but the loss is nondeductible since it is from personal use property. The gift of $4,000 from Matt's mother is nontaxable.

1. Matt and Anita can claim two personal exemptions for themselves. Dependency exemptions for all four children are taken as there is no indication that Anita agreed to award the dependency exemption for the oldest child to his or her father (the noncustodial parent). Anita's windowed mother qualifies as a dependent. Anita's grandparents also qualify. Although they are not U.S. citizens or residents, they fall under the Mexico exception.

1. Matt and Anita's filing status is married filing jointly. Their tax liability is $5,189 ($34,590 X 15%).

17. The receipt of the common stock is not taxable to Sandra because it is a non-cash transfer of property under the terms of a divorce. The $300 per month actual child support payments are not included in Sandra's gross income. The $1,000 monthly payment includes $250 of implicit child support. That is, because the payments would be reduced as a result of a contingency related to the child (i.e., attaining age 21), the amount of the contingent reduction is child support. Therefore, Sandra must include only $4,500 ($750 X 6) in gross income in the current year. pp. 15-26 and 15-28

18. a. Joe is required to include $110,000 ($60,000 + $50,000) in gross income associated with the award he received. The award does not satisfy the right type of achievement requirement to qualify for exclusion from gross income. In addition, the provision which requires the recipient to contribute the award to a qualified governmental unit or nonprofit organization is not satisfied.

b. Wanda is required to include the $75,000 of prizes received in her gross income. She is required to render substantial future services. In addition, the provision which requires the recipient to contribute the award to a qualified governmental unit or nonprofit organization is not satisfied.

c. George can exclude the $950,000 prize received from his gross income. All of the requirements for exclusion are satisfied.

pp. 15-28 and 15-29

20. a. Liz must include in gross income the punitive damages of $30,000. The other amounts ($8,000 and $6,000) may be excluded as arising out of the physical injury, except the $1,000 amount received for damage to her automobile. This amount is a nontaxable recovery of capital (i.e., it reduces her basis for the automobile by $1,000).

b. The $40,000 is included in Liz's gross income because it did not arise out of a physical personal injury. p. 15-31

21. General discussion. All of the following expenses are deductible, subject to the 7.5% floor: $1,600 for medical insurance, $6,000 in doctor bills and hospital expenses, and $900 for prescribed medicine and drugs.

1. If Ed and Laura itemized in 1998, they would report the reimbursement as gross income in 1999 to the extent they received a tax benefit from itemizing in 1998. If they did not itemize in 1998, they would not be required to report the reimbursement as gross income in 1999.

pp. 15-35

22. Steven primarily was interested in cosmetic surgery to improve his appearance by shortening his nose. This would be considered unnecessary cosmetic surgery and, therefore, nondeductible. He then discussed the surgery with his CPA and found that it would be deductible if performed for a medical reason.

Dr. Keane indicated that Steven had a medical problem (deviated septum) that could be repaired by surgery, and that he would be willing to write a letter to that effect.

23. Ahmad should be concerned with the following tax issues:

• Is the value of the certificate includible in gross income in 1997, even though it appeared at that time that Ahmad would not have any need for the operation?
• If Ahmad uses the certificate for his daughter, is the prize includible in gross income in 1998?
• If Ahmad pays for the prescription glasses for his daughter, can he take a medical expense deduction?
• If Ahmad uses the certificate for an operation for his daughter, can he take a medical expense deduction? If so, what is his basis in the certificate and what is the amount of his medical expense deduction?

pp. 15-26 and 15-35

24. a. A capital improvement that ordinarily would not have a medical purpose qualifies as a medical expense if it is directly related to prescribed medical care and is deductible to the extent that the expenditure exceeds the increase in value of the related property. The deduction is $1,900 [($7,200 - $2,300) - ($40,000 X 7.5%)].

b. The full cost of certain home-related capital expenditures incurred to enable a physically handicapped individual to live independently and productively qualifies as a medical expense. Qualifying costs include expenditures for constructing entrance and exit ramps to the residence, widening hallways and doorways to accommodate wheelchairs, installing support bars and railings in bathrooms and other rooms, and adjusting electrical outlets and fixtures. These expenditures are subject to the 7.5% floor only, and the increase in the home's value is deemed to be zero. Ibrahim's deduction is $4,200 [$7,200 - ($40,000 X 7.5%)]. p. 15-35

25. General discussion. A cash basis taxpayer deducts state income taxes in the year paid or withheld. Any refund of state income taxes must be reported as income in the year received to the extent the taxpayer received a tax benefit from itemizing deductions in a prior year. The income must be reported whether the taxpayer receives a cash refund or has the refund applied against taxes.

1. $7,400 withheld in 1998 + $700 estimated tax payment in 1998 + $1,000 paid in 1998 for 1997 = $9,100.
2. The $1,800 will be included in 1999 gross income to the extent the taxpayer derived a tax benefit from itemizing in 1998.
3. The $1,800 will be included in 1999 gross income to the extent the taxpayer derived a tax benefit from itemizing in 1998, even if she elects to have the refund applied toward her 1999 state income tax.
4. If Andrea did not itemize deductions in 1998, she is not required to report any of the $1,800 refund as income in 1999.

p. 15-38

26. a. Irina can elect to include the net capital gain in investment income for purposes of computing the investment interest expense limitation. If she makes the election, her investment income for purposes of computing the investment income limitation is $31,000 ($10,000 interest + $6,000 dividends + $15,000 net capital gain).

27. a. For purposes of determining net investment income, Myrna's investment expense is the smaller of (1) $500 (the amount of investment expenses included in the total of miscellaneous itemized deductions subject to the 2% of AGI floor), or (2) $1,940 (the amount of miscellaneous expenses deductible after the 2% of AGI rule is applied) [$2,340 ($1,400 + $440 + $500) - $400 (2% of $20,000)]. Therefore, Myrna's net investment income is determined as follows.

b. In this case, Myrna's investment expense is the smaller of (1) $500 (the amount of investment expenses included in the total of miscellaneous itemized deductions subject to the 2% of AGI floor), or (2) $1,140, (the amount of miscellaneous expenses deductible after the 2% of AGI floor is applied) [$2,340 ($1,400 + $440 + $500) - $1,200 (2% of $60,000)].

Myrna's net investment income is determined as follows:

c. Investment expense, in this case, is the smaller of (1) $500 (the amount of investment expenses included in the total of miscellaneous itemized deductions subject to the 2% of AGI floor), or (2) $140, (the amount of miscellaneous expenses deductible after the 2% of AGI floor is applied) [$2,340 ($1,400 + $440 + $500) - $2,200 (2% of $110,000)].

Myrna's net investment income is determined as follows:

p. 15-40

• The fair market value of the residence, reduced by the acquisition indebtedness ($200,000 FMV - $85,000 acquisition indebtedness = $115,000).
• $100,000 ($50,000 for married persons filing separate returns).

30. Hoffman, Smith, and Willis, CPAs

December 5, 1998

Ms. Alice Young

2622 Bayshore Drive

Berkeley, CA 94709

Dear Ms. Young:

I have evaluated the proposed alternatives for your 1998 year-end contribution to the United Way. I recommend that you sell the Gold Corporation stock and donate the proceeds to the United Way. The four alternatives are discussed below.

Donation of cash, the unimproved land, or the Gold stock will each result in a $21,000 charitable contribution deduction. Donation of the Blue Corporation stock will result only in a $3,000 charitable contribution deduction.

A direct contribution of the Gold Corporation stock will be a bad move taxwise in that the decline in value of $5,000 ($21,000 - $26,000) is not deductible and the amount of the charitable contribution would be $21,000. However, you will benefit in two ways if you sell the Gold stock and give the $21,000 in proceeds to the United Way. Donation of the proceeds will result in a $21,000 charitable contribution deduction. In addition, sale of the stock would result in a $5,000 long-term capital loss. If you have capital gains of $2,000 or more in 1998, you could use the entire loss in computing taxable income for 1998. If you have no capital gains in 1998, you can deduct $3,000 of the capital loss in 1998 and carry the remaining $2,000 over to 1999.

You should make the donation in time for ownership to change hands before the end of the year. Therefore, I recommend that you notify your broker immediately so there will be no problem in completing the donation on a timely basis.

I will be pleased to discuss my recommendation in further detail if you wish. Please call me at (510) 555-1234 if you have questions. Thank you for consulting my firm on this matter. We look forward to serving you in the future.

Sincerely,

Nora Oldham, CPA

Partner

Concept Summary 15-3

31. The following tax issues relate to prizes won in the Skins Game:

• Are the prizes won (monetary and nonmonetary) included in gross income?
• Should the players report only 90% of the total amount of money winnings as income and claim no deduction for the amount that goes to charity?
• Should the players report the total amount of money winnings as income and deduct the 10% that goes to charity as a charitable contribution? If so, is the deduction a business expense or an itemized deduction?
• What amount should be reported as income for the automobile won by the leading money winner - the sticker price, the average selling price, or some other amount?
• If the average selling price is the appropriate amount to report as income, how should it be determined?

The following questions relate to material covered in other chapters:

• If the leading money winner already has an automobile and doesn't need the new one, what will be the tax result when he sells the automobile he won as a prize? What is his basis in the automobile won as a prize? What kind of gain (loss) would result? If a loss results, is it deductible?
• If the leading money winner keeps the automobile he won as a prize and sells the automobile he had been using previously, what will be the tax result when he sells his old automobile? What kind of gain (loss) would result? If a loss results, is it deductible?
• What will be the tax result if the leading money winner gives the new automobile to a friend or relative
• What will be the tax result if the leading money winner gives the new automobile to a charity?
• What will be the tax result if the leading money winner gives the new automobile to his caddy, who is an employee

33. a. Ann and Bill must claim the adoption expense credit in the year in which the adoption becomes final, since they paid or incurred qualified adoption expenses prior to the year in which the adoption was finalized. In their particular case, they may take the credit in 1999 for $5,000. The amount of expenses paid in excess of $5,000 is a nondeductible personal expense. Further, because their modified AGI is less than $75,000, the amount of the credit otherwise available is not reduced.

b. $1,875 = $5,000 - [$5,000 [($100,000 - $75,000) ÷ $40,000]]

pp. 15-19

34. a. Durell and Earline may only claim the child tax credit for their two children, ages 5 and 6 months. The full amount of the child tax credit is available for qualifying children born during the tax year. Although Earline's son from a previous marriage is claimed as a dependent, he is not eligible for the child tax credit since he is not under age 17. Since Durell and Earline's combined AGI is below $110,000, their child tax credit is $800 for 1998.

1. Since Durell and Earline's combined AGI exceeds $110,000, the maximum child tax credit of $800 must be reduced. The credit reduction is computed as $50 for each $1,000 of AGI or fraction thereof exceeding the threshold amount.

$9,000 X $50 = $450 reduction.

$1,000

Durell and Earline's child tax credit is $350 ($800 maximum credit - $450 reduction) for the year.

p. 15-53

35. For two children, the maximum expense allowed is $4,800. However, since the qualifying expenditures are limited to the earnings of the lesser paid spouse (i.e., $4,500), this amount is used in calculating the credit. Using the combined AGI of $16,500 ($12,000 + $4,500), the applicable rate for the credit is 26%. Thus, the credit is $1,170 (26% X $4,500).

The fact that the care was provided by Jim's mother is of no consequence as long as the mother does not qualify as Jim's and Jill's dependent.

36. a. Colin is able to take education tax credits for both Eliza and Rhett's schooling since both children are claimed as dependents on Colin's tax return. Eliza is eligible for the HOPE scholarship credit while Rhett's expenses are eligible for the lifetime learning credit, since he is beyond the first two years of post-secondary education. Room, board, and book costs are not eligible for the credits.

The maximum HOPE scholarship credit for Eliza's tuition is $1,500 [100% X first $1,000 of tuition expenses + 50% of second $1,000 of tuition expenses]. The maximum lifetime learning credit for Rhett's tuition is $800 [20% X $4,000]. The full $1,000 lifetime learning credit is not available for Rhett's expenses since his tuition expenses ($4,000 per semester) were paid at the beginning of each semester.

Since the education tax credits are phased-out for higher income taxpayers, Colin will not receive the total $2,300 ($1,500 + $800) in education credits for Eliza and Rhett's expenses. The credit reduction is $1,725 [($95,000 AGI - $80,000 threshold)/$20,000 phase-out range X $2,300], resulting in a $575 ($2,300 - $1,725) education credit for 1998.

1. Colin could increase his education credit for 1998 by prepaying at least $1,000 of Rhett's Spring 1999 tuition expenses during 1998. If tuition expenses are paid during the tax year for an academic period beginning during the first three months of the following tax year, the expenses may be claimed during the payment year for purposes of the credit computation. The lifetime learning credit would have then been available on $5,000 of qualifying expenses resulting in a $1,000 credit before reduction for Colin's AGI level.

p. 15-55

37. a. Bernadette is eligible to take the lifetime learning credit for qualifying tuition expenses for her continuing professional education seminars and her son's tuition costs. The costs for books incurred both by Bernadette and her son are ineligible for the credit. Until the year 2003, the lifetime learning credit is available per taxpayer on the first $5,000 of qualifying tuition expenses. Accordingly, Bernadette's course tuition ($2,000) plus up to $3,000 of her son's tuition would qualify for the credit during 1998. Bernadette should pay her son's tuition in installments in an attempt to have no more than $3,000 qualify for the credit during 1998. Assuming that occurs, Bernadette's maximum lifetime learning credit would be $1,000 [20% X $5,000] for 1998. The $1,000 maximum credit would have to be reduced by $400 since her $88,000 AGI exceeds the threshold level of $80,000 for married taxpayers.

[($88,000 - $80,000) / $20,000] X $1,000 = $400 reduction

p. 15-55

1. "How the Tax Law Can Help Pay for College and Continuing Professional Education" Outline for Presentation to Rotary Club

1. Introduction.
1. Many tax provisions are available to help defray the cost of both college and continuing professional education.
2. Complicated area of tax law so planning ahead is important.

1. Tax provisions that help pay for college.
1. Contributions to education IRAs
2. Penalty-free withdrawals to pay for college from regular IRAs or Roth IRAs.
3. Participation in state-level prepaid tuition plans for tuition and room and board costs.
4. Deductibility of student-loan interest
5. Purchase of Series EE education bonds.
6. Education tax credits - HOPE scholarship credit and, lifetime learning credit
7. Employer education assistance programs

1. Tax provisions that help pay for continuing education.
1. Lifetime learning credit
2. Employer education assistance programs
3. Deductibility of expenses ineligible for credit or assistance program

IV. Income limitations and interaction among various provisions also are important issues

The credit allowed may not exceed the amount of the tax liability of $150. This credit does not qualify for carryback or carryover treatment. pp. 15-57

p. 15-59

(1) Itemized deductions are summarized below:

Alice and Bruce would elect to itemize their deductions because the total exceeds the standard deduction of $6,900 for 1997 for married persons filing a joint return.

(2) In addition to the Byrd's two children, Cynthia and John, Alice's mother qualifies as a dependency exemption because her Social Security benefits do not count as her own support when they are not spent for that purpose. Bruce's father, Sam, qualifies as a dependency exemption under a multiple support agreement.

(1) Itemized deductions are summarized below:

Alice and Bruce will use the standard deduction because itemized deductions are less than the standard deduction of $7,100.

(2) Itemized deductions:

Medical expenses:

(3) Since Donna is the custodial parent, the Decker's qualify for the dependency deduction for both Larry and Jane. Since they provide over 50% of the support of Hannah, they also qualify for a dependency deduction for her. Thus, the personal exemption and dependency deduction is $13,250 ($2,650 X 5).

(4) Consumer interest is not deductible. Therefore, neither the interest on the auto loan of $920 nor the credit card interest of $855 is deductible.

42. a.

Hoffman, Smith, and Willis, CPAs

5101 Madison Road

Cincinnati, OH 45227

November 10, 1998

Ms. Susan Carpenter

3126 Kingsride Road

Funston, Utah 84602

Dear Susan:

Although you are still legally married, for Federal income tax purposes you are treated as a single person. This is important for three reasons. First, you can claim a credit for child care costs. If you were treated as a married person, the credit would not be available unless a joint return is filed. Second, you can avoid the high tax rates applicable to married persons filing separately. Instead, you can use the tax rates available to single persons. Third, you are entitled to a greater standard deduction than is available to married persons filing separately.

I would be delighted to be of further assistance to you in this matter.

Sincerely,

Jake Woods, CPA

Tax Manager

b.

TAX FILE MEMORANDUM

TAX FILE MEMO

FROM: Jake Woods

SUBJECT: Inquiry from Susan Carpenter Regarding Filing Status and Other Related Issues.

A letter was sent (copy attached) to Mrs. Carpenter regarding her status as an abandoned spouse. As such she qualifies for Federal income tax purposes as a single person. In accordance with Mary Lee Sharer [68 TCM 686, T.C.Memo. 1994-453], this also allows her to claim a credit for child care costs without having to file a joint return.

43. A person's marital status is determined on the last day of the tax year. An exception is allowed when a spouse dies during the year, Furthermore, the Lee case (citation given in the research aids) establishes the usual rule that marital status is determined by looking to state law. So far, therefore, it seems that Judy should be considered as single for all open tax years.

Annulment of a marriage, however, is a procedure intended to affect only the parties involved (i.e., the spouses before the court). It is a legal fiction that should not operate to cause detriment to third parties (e.g., the IRS).

In Shackelford (citation given in the research aids), the Tax Court found that the annulment procedure should not be recognized for filing purposes. Thus, if the parties were in fact married at the end of the year, then they must be treated as such. Accordingly, Judy was not "single" but "married filing separate."

44. a. Section 213 contains no ceiling limit on the amount of medical expenses.

b. A capital expenditure will qualify as a medical expense if its primary purpose is the medical care of the taxpayer, the taxpayer's spouse, or the taxpayer's dependent. However, the medical expense qualifies only to the extent that the expenditure exceeds the increase in value of the related property (if the expenditure is directly related to medical care). Reg. § 1.213-1(e)(iii).

c. The facts in the research problem are similar to those in Collins H. Ferris, 36 TCM 765, T.C. Memo. 1977-186, where the IRS argued that the medical expense deduction should be limited to the cost necessary to produce a functionally adequate facility. The Tax Court held that the deduction did not have to be based on the cost of the least expensive pool that could have been built. The Tax Court said that there was no case law limiting a medical expense to the cheapest form of treatment. This Tax Court decision has been reversed by the Seventh Court of Appeals, which held for the IRS (1978-2 USTC ¶ 9646, 42 AFTR2d 78-5674, 582 F.2d 1112 (CA-7, 1978). The Court of Appeals held that the deductible amount should have been the minimum cost of a functionally adequate pool and housing structure.

45. a. The portion of the payments which are contingent upon their son's living are child support. The remaining portion of the payments qualifies as alimony. Therefore, Al has $55,000 ($60,000 - $5,000) alimony from the Year 1 payment.

b. Alimony paid for the first three years is $55,000 for year 1, $40,000 for year 2, and $15,000 for year 3. Alimony recapture is computed as follows:

Year 2 alimony recapture:

*Earned income ($19,500) is greater than AGI ($19,000).

pp. 15-59

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