CHAPTER 16

INDIVIDUALS AS EMPLOYEES AND PROPRIETORS

SOLUTIONS TO PROBLEM MATERIALS

1.

a.

 None. Section 106 excludes the value of hospitalization insurance coverage for the employee and his or her dependents. pp. 16-5 to 16-6

b.

 None. Medical reimbursement can be excluded if the plan is nondiscriminatory. pp. 16-6

c.

 $243.60, the standard premium on group term life insurance in excess of $50,000, i.e., [$.29($120 - $50)(12)]. pp. 16-9 and 16-10

d.

 $2,600. The salary continuation payments constitute gross income and no exclusion applies.The $1,600 that was collected on the policy Rex purchased is not included in his gross income. p. 16-6

4.

a. .

 Alice must include the $6,000 in gross income. Occupying this particular house has nothing to do with the performance of her services. In addition, the house would not satisfy the "on the employer's business premises" requirement for the meals and lodging exclusion

b.

 The facts do not state that eating on the premises has anything to do with Pam's performance of her job. Thus, the meals are not for the convenience of the employer and are includible in Pam's gross income [($4.00 - $.50)(150) = $525]. If the meals were for the convenience of the employer, they would qualify for exclusion treatment.

 Note: The employee's income is based on the value of what she receives ($4.00 per meal) rather than the employer's cost. pp. 16-7 to 16-9

6.

a.

 The football tickets probably do not qualify as a de minimis fringe benefit exclusion. Their exclusion seems unlikely because it is easy to account for the cost. In addition, Temp. Reg. § 1.132-6T(f)(2) specifically provides that season tickets to sporting events do not qualify as de minimis fringes. p. 16-15

b.

 Parking is a qualified transportation fringe and, thus, can be made available in a discriminatory manner. Therefore, the $1,200 is not taxable because it is less than the $175 per month limit on the exclusion. p. 16-16

c.

 Other employee’s use of the copying machine may be a de minimis fringe, but Polly’s use was probably so extensive that it will not qualify for this exclusion. However, Polly may be able to relate these expenses to the company’s business. The company benefits from her involvement with the trade association and, thus, the company could justify the expenses under § 162. The $900 is the company’s expense and not Polly’s income. The expenses should qualify as a working condition fringe because Polly could deduct the expenses if she had paid them. p. 16-15

d.

 The freight is a no-additional-cost benefit made available to all employees (nondiscriminatory). The $600 can be excluded. p. 16-14

e.

 The plan is discriminatory. Therefore, the highly compensated employees must pay tax on all of their discounts. Polly includes $400 in her gross income. pp. 16-14

10.

 Alec’s deduction for the year is computed as follows:

 32 miles (distance from first job to second job) X 200 (workdays) X $0.325 (automatic mileage method) = $2,080.

 Note that it is the distance from the first job to the second job that controls. Thus, it does not matter that on 50 days Alec returned home before going to the second job.

 Example 24 and pp. 16-19 and 16-20

11.

The adjusted basis of the business portion of Heidi's automobile is calculated as follows:

Cost ($32,000 X 80%)

25,600

1995 (11,000 miles X 12 cents X 80%)

(1050)

1996 (18,000 miles X 12 cents X 80%)

(1728)

1997 (12,000 miles X 12 cents X 80%)

(1152)

1998 (14,000 miles X 12 cents X 80%)

(1344)

Adjusted basis on 1/1/99 of business portion

20320

Heidi’s basis is the sum of the business portion basis and the personal portion basis:

Business portion adjusted basis

20320

Personal portion basis ($32,000 X 20%)

6400

Total basis

26720

12.

Travel days count as business days, so Louis had ten business days and five personal days. The trip was within the U.S., so he can deduct the $950 of air fare. He can deduct 2/3 (10 business days/15 total days) of the lodging, or $1,600. In addition, he can deduct a portion of the meals and entertainment:

Airfare

950

Lodging(2400X1/3)

1600

Meals ($1,200 X 2/3)

800

Entertainment

800

1600

50% allowed portion

800

Miscellaneous itemized deduction (subject to the 2% of AGI floor)

 3350

  All of the above expenses are miscellaneous itemized deductions subject to the 2% of AGI floor. Example 39 and p. 16 -24

13.

Chad’s deduction is determined as follows:

Airfare

$ 420

Hotel

330

Meals (50% X $160)

80

Registration and course materials

280

$1,110

.

 Since Chad is self-employed, a deduction of $1,110 for AGI can be claimed

17

a

Dudley’s deduction is determined as follows

Taxi fares

380

Meals

4100

Tips

720

Cover charges

600

5420

Less cutback adjustment

(2710)

2710

Total Deduction

3090

18.

An owner-employee owns the entire interest in an unincorporated business. Section 401(c)(3)(A)

a.

$30,000, which is 20% X $150,000. p. 16-44 and Example 73

b.

Contributions in excess of the allowable amount under § 415 are not deductible, and may be subject to a 10% excise tax.

c.

No, Susan may not begin receiving payments until age 59.5 without incurring a 10% penalty. § 72(m)(5). p. 16-44

20

a.

$4,000. A homemaker may take a full $2,000 deduction to a traditional IRA. Juan and Agnes may each contribute $2,000. p. 16-39

b.

$4,000. Their combined earned income exceeds $4,000. Thus, each may contribute $2,000. p. 16-39

c.

Leo is allowed a deduction for an amount that is equal to the smaller of $2,000 or 100% of his compensation for the year, regardless of employer contributions to the SEP, because his AGI is less than $30,000. Thus, Leo may contribute $2,000 to an IRA.

22

Calculation of Ruth's home office deduction:

Income

$5,000

Less: Consulting expenses other than home office

(2,400)

$2,600

Less: Home office expenses

Interest and taxes (1/5 X $6,000)

(1,200)

$1,400

Utilities (1/5 X $2,000)

( 400)

$1,000

Repairs and maintenance (1/5 X $600)

( 120)

$ 880

Depreciation ($1,500 limited to $880)

( 880)

$   -0-

Calculation of AGI:

AGI

$50,000

Consulting income

$5,000

Less: expenses (above)

(5,000)

AGI

$50,000 

Ruth can deduct $4,800 ($6,000 less $1,200) of interest and taxes as an itemized deduction.

Ruth has a home office deduction carryover of $620 [$1,500 - $880] for the disallowed depreciation.

24.

 Thus, of the $4,400 reimbursement, 30%, or $1,320, applies to meals and entertainment and 70%, or $3,080, applies to the other employee expenses. The deductions for AGI and from AGI are reported on Form 2106 in the following manner:

Other than entertainment and meals

Meals and entertainment

Transportation

$3,200

Lodging and incidentals

2,300

Dues and subscriptions

100

Meals and entertainment ($1,400 + $1,000)

    0     

$2,400

Total business expenses

$5,600

$2,400

Less: Reimbursement under accountable plan (amount of expense deductible for AGI)

(3,080)

(1,320)

Unreimbursed portion

$2,520

$1,080

Less: Reduction of meals and entertainment (50% X $1,080)

( 540)

Unreimbursed expenses (deductible from AGI)

$2,520

$ 540

  The totals from Form(s) 2106 are reported on Schedule A, then reduced by 2% of AGI: 

Total unreimbursed employee expenses ($2,520 + $540)

$3,060

Less: 2% of $50,000 AGI

(1,000)

Total deductible from AGI

$2,060

p. 16-36

25

Gross profit

$63,000

Less: Business expenses

(15,000) 

Net earnings from self-employment

$48,000

Helen will be required to pay the Social Security portion of the self-employment tax on the lesser of the net ceiling or the net self-employment income calculated as follows: 

Ceiling amount

$68,400

Less: FICA wages

(24,000)

Net ceiling

$44,400

Net self-employment income ($48,000 X 92.35%)

$44,328

Lesser of net ceiling or net self-employment income

$44,328

Therefore, Helen is subject to self-employment tax for the Social Security portion of $5,497 ($44,328 X 12.4%).

In addition, all of Helen’s net self-employment income is subject to the 2.9% Medicare portion of the self-employment tax. This portion of the tax is $1,286 ($44,328 X 2.9%), along with the $5,497 calculated above, results in a total self-employment tax liability of $6,783 ($1,286 + $5,497).

For income tax purposes, Helen reports $48,000 as net earnings from the business and has a deduction for AGI of $3,392 (one-half of the self-employment tax paid). pp. 16-42, 16-43, and Example 72

The casualty loss of $1,200 is excluded in the computation of self-employment income. Reg. § 1.1402(a)-6

26

1

Net earnings from self-employment

$150,000

2

Multiply line 1 by 92.35%.

$138,525

3

If amount on line 2 is $68,400 or less, multiply line 2 by 15.3%. This is the self-employment tax

4

If amount on line 2 is more than $68,400, multiply the excess over $68,400 by 2.9% and add $10,465.20. This is the self-employment tax

$12,498.83

27

a

If the antique book business is classified as a hobby, Sandra’s deductions associated with the hobby may not exceed her gross income from this activity.  

Income from sale of antique books

$22,000

Deduct: Property taxes and mortgage interest

-0-

Remainder

$22,000

Deduct: Other expenses which do not affect basis

Cost of goods sold

$12,000

Show registration costs

3,000

Advertising

1,000

Dealer’s license

500

Insurance

900

(17,400)

Remainder

$ 4,600

Deduct:

Depreciation

( 1,200)

Net income

$ 3,400

Thus, it appears that the antique book activity will increase Sandra’s taxable income by $3,400. However, since the activity is a hobby, all of the deductible expenses (except for any property taxes and mortgage interest) are miscellaneous itemized deductions which are subject to the 2% of the AGI floor.

AGI ($90,000 + $22,000)

$112,000

Rate

X 2%

Floor on deducting MID

$ 2,240

Antique books activity expenses ($17,400 + $1,200)

$ 18,600

Less: Floor on MID

( 2,240)

Deductible MID

$ 16,360

Sandra’s taxable income is calculated as follows:

Gross income:

Net income from orthodontic practice

$ 90,000

Income from sale of antique books

22,000

AGI

112,000

Personal exemption deduction

( 2,700)

Itemized deductions:

Taxes, interest, and charitable contributions

($19,000)

Miscellaneous itemized deductions[$18,600 – 2% ($112,000)]

(16,360)

Taxable income

$ 73,940

b

If the antique book activity is classified as a business, Sandra’s taxable income is calculated as follows:

Adjusted gross income:

Net income from orthodontic practice

$90,000

Net income from antique business:

Income from the sale of books

$22,000

Expenses:

Cost of goods sold

$12,000

Show registration costs

3,000

Advertising

1,000

Dealer’s license

500

Insurance

900

Depreciation on display

1,200

(18,600)

3,400

AGI

$93,400

Personal exemption deduction

(2,700)

Itemized deductions (taxes, interest, and charitable contributions)

(19,000)

Taxable income

$71,700

pp. 16-48