a. Taxable income b. Income (broadly conceived)
c. Adjusted gross income d. Deductions for AGI e. The greater of the standard deduction or itemized deductions f. Personal and dependency exemptions h. Gross income i. Exclusions Otherwise stated: b. – i. = h. – d. = c. – e. – f. = a. The income tax withheld (choice g.) is subtracted from any income tax liability to arrive at the tax due (or refund). Figure 3-1 3. All items (a., c., d., e., f, g.) except b. are inclusions in gross income. Item b. is a nontaxable return of capital. p. 3-3 and Exhibit 3-2 5. Double taxation will occur if the country where the services are performed imposes an income tax. The compensation income earned in the foreign country also is subject to U.S. tax, due to the application of the global (or worldwide) tax approach. U.S. tax law, however, does mitigate the double tax result by allowing an exclusion for foreign earned income and/or a credit for foreign taxes paid. Global Tax Issues, p. 3-5 The Andersons are expecting more than they will receive. To take advantage of the medical deduction, taxpayers must itemize. By itemizing, the standard deduction (including the additional standard deduction for age 65 or older) cannot be claimed. Thus, the Andersons can claim a tax benefit from either their medical expenses or their age but not from both. pp. 3-7 and 3-8
9.a. The non-filing spouse has no gross income and is not claimed as a dependent of another taxpayer. b. Yes, it would matter. Barring some special agreement between the parties, onehalf of the filing spouse’s income would be assignable to the non-working spouse. This will make the no-income requirement impossible to meet. 11. p. 3-11 a. Heather is a qualifying child to all three parties. b. As the parent, the mother takes precedence. If the mother waives, the exemption goes to whoever has the highest AGI as between the grandmother and the uncle. c. The father should not be an eligible party due to the abode test. (Note: As the facts do not indicate otherwise, it is assumed that Heather’s parents are not divorced). Table 3-4
Probably Margo’s income is such that her personal and dependency exemptions are subject to a phaseout. At the other extreme, Margo’s AGI could be so low that another dependency exemption provides no tax benefit. p. 3-19 a. The variation occurs because the tax for a particular income range in the Tax Table is based on the midpoint amount. See the computation described in Example 31. b. No. Except in limited situations described on p. 3-20 of the text, all taxpayers must use the Tax Table method.
a. If either spouse itemizes deductions from AGI, the other spouse also must itemize. Consequently, Jack’s suggestion is not proper. b. Presuming they file separately and itemize, their total deduction is $8,000 ($7,500 + $500). If they claim the standard deduction, $10,900 ($5,450 + $5,450) is allowed. The same result takes place on a joint return. For tax purposes, therefore, the standard deduction is the better choice. p. 3-29 and Table 3-1
a. Head of household filing status is available since only one parent needs to qualify as a dependent. b. Head of household filing status is available since the son is a dependent under the qualifying child category. c. Head of household filing status is not available. Due to the age test, the son is not a qualifying child. (It is assumed that the son is not disabled or a full-time student.) Due to the gross income test, the son does not satisfy the requirements of a qualifying relative. d. Head of household filing status is not available. The daughter is not a member of taxpayer’s household. pp. 3-30 and 3-31
21. 23. 25.
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. pp. 3-31 and 3-32 One reason might be that her tax bracket is 15% or less. If so, her tax rate on a long-term capital gain is 5% in 2007 and 0% in 2008. p. 3-33 a. The short-term capital loss is first offset against the long-term capital gain from the gun collection. This has the effect of preserving more of the long-term capital gain from the sale of the land. Because the long-term capital gain from collectibles is taxed at a maximum of 28% while regular long-term capital gains are taxed at a lower 15%, the offset sequence followed in part a. favors taxpayers. p. 3-34 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. pp. 3-36, 3-37, and Example 56 29. Salary Alimony paid Capital loss IRA contribution Office pool AGI Standard deduction Personal and dependency exemptions (3 × $3,500) Taxable income $70,000 (6,000) (3,000) (5,000) 1,500 $57,500 (5,450) (10,500) $41,550
The alimony payments are deductible. The gift and bond interest are nontaxable exclusions. Only $3,000 of the capital loss is deductible—the balance of $2,000 is carried over to 2009. 31. pp. 3-5, 3-6, 3-34, Figure 3-1, Exhibits 3-1 and 3-2, and Table 3-1 a. $5,450. Although $5,200 (earned income) + $300 = $5,500, the amount allowed cannot exceed that available in 2008 for single taxpayers. b. $3,900. $3,600 (earned income) + $300. c. $1,000. The greater of $900 or $700 (earned income) + $300. d. $900. The greater of $900 or $500 (earned income) + $300. e. $3,650. $2,000 (earned income) + $300 + $1,350 (additional standard deduction). 33. pp. 3-9, 3-10, Tables 3-1 and 3-2, and Examples 8 to 11 a. Four. Two personal and two dependency exemptions. Elton is a qualifying child, so his gross income does not matter. Trista is not a qualifying child—although a full-time student, she is not under age 24. However, Trista fits under the qualifying relative category. She passes the gross income test because the tuition portion of a scholarship is nontaxable. b. Two. One personal and one dependency exemption. Regardless of the year of divorce, Clint cannot qualify as he is not a member of Audry’s household. Olive meets the relationship test. c. Two. One personal and one dependency exemption. As a daughter, Carin is a qualifying chld. Pierce, who is not a qualifying child, cannot come under the qualifying relative category due to the gross income test. (Note: The joint return test appears inapplicable in this case.) d. Three. One personal and two dependency exemptions. Pierce’s income is now $2,000 (50% × $4,000), and he satisfies the gross income test of less than $3,500.
pp. 3-10 to 3-17 35. a. Three. The niece is in the qualifying child category. The cousin and son are not, due to the relationship and age tests. They both come within the qualifying relative category. b. Two. Both persons come within the qualifying relative category. The stepmother meets the relationship test, while the family friend’s son is a member of taxpayer’s household. c. One. Helena is a qualifying child under the exception to the citizenship or residency test. She lives with her adoptive father who is a U.S. citizen. d. Two. Two come under the qualifying relative category, and it has been assumed that each meets the gross income test. The mother- and brother-in-law satisfy the relationship test. While the ex-husband is a member of the household, he cannot qualify in the year of the divorce. The brother-in-law’s age and non-student status have no bearing on the dependency issue. Example 29 and Concept Summary 3-1 37. a. Three. As a niece, Ida is a qualifying child. Under the qualifying child category, Ida does not have to meet a gross income test. In this regard and because of her age, her student status makes a difference. b. One. Since Clint is not a qualifying child, the gross income test does apply. c. Three. The parents need not live with Trent as they meet the relationship test. Though not stated, it is assumed that the gross income test is satisfied. d. One. Carol can claim a personal exemption. Because of the divorce decree, the dependency exemptions for the children are awarded to Jack (Carol’s exhusband). pp. 3-10 and 3-17 39. Exemption amount (10 × $3,500) Step 1: AGI $280,000 Phaseout threshold (239,950) Excess amount $ 40,050 Step 2: $40,050 ÷ $2,500 = 17 (rounded up) × 2 = 34% (phaseout percentage) Step 3: $35,000 × 34% = $11,900 (exemption phaseout) Step 4: $11,900 × 1/3 (reduction-of-phaseout fraction) = $3,967 (adjusted phaseout) Step 5: Allowable exemption deduction $35,000
Example 30 a. Regardless of where the parties reside, it is essential that the damage of the joint return be undone. The joint return test applies to both the qualifying child and qualifying relative categories of dependency exemptions. The situation can be rectified by filing separate returns on or before April 15, 2009. In Louisiana, one-half of the daughter’s income, or $5,500 (50% × $11,000), is assigned to John. Being a qualifying child, the daughter can be claimed as a dependent.
John, however, is subject to the gross income test contained in the qualifying relative category. Since $5,500 exceeds $3,500, John cannot be claimed as a dependent. b. As noted in part a., the joint return problem needs to be resolved. In New Jersey, none of the daughter’s income is earned by John. Consequently, John now meets the gross income test of a qualifying relative. The daughter also can be claimed as a dependent since there is no gross income test applicable to the qualifying child category. 43. Examples 52, 54, and 55 Unearned income Minus: $900 base amount + $900 standard deduction Unearned income taxed at parents’ rate $2,400 (1,800) $ 600
Terri’s parents are in the 25% bracket, so her unearned income would generate $150 of tax (25% × $600). Computation of Terri’s taxable income and tax: Earned income Interest income Gross income Less: Personal exemption Less: Standard deduction [greater of $900 or $1,900 (earned income) + $300] Taxable income Less: Unearned income taxed at parents’ rate Income taxed at Terri’s rate Terri’s tax rate Tax at Terri’s rate $1,900 2,400 $4,300 (–0–) (2,200) $2,100 (600) $1,500 × 10% $ 150
Terri’s total tax: $150 (unearned income taxed at parents’ rate) + $150 (taxed at Terri’s rate) = $300. 45. Example 36 a. Sam and Lana must file since their gross income of $20,200 is more than the $20,000 filing requirement. b. Ronald 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 $5,450 (his standard deduction). c. Mike need not file since his gross income of $10,100 is less than the $10,300 filing requirement.
d. Patricia is required to file. Her gross income is less than $8,950, but her net earnings from self-employment are more than $400. Taxpayers in a. and c. should file, even if a return is not required, to obtain a refund if any income tax was withheld. p. 3-25 and Table 3-6 47. a. If they stay single, each has a tax liability of $13,844. Using the tax rate schedules for 2008 applicable to single persons, the tax on $70,000 (taxable
income) is $4,481.25 + 25%($70,000 – $32,550) = $13,843.75, or $13,844 (rounded). Thus, their combined tax liability is $27,688 ($13,844 + $13,844). If they marry in 2008, the following results: Gross income (and AGI) ($76,950 + $76,950) Standard deduction (married persons filing jointly) Personal exemptions ($3,500 2) Taxable income $153,900 (10,900) (7,000) $136,000
Tax on $136,000 using the rate schedule for married persons filing jointly is $25,550 + 28%($136,000 – $131,450) = $26,824. Thus, Spencer and Ava save $864 ($27,688 – $26,824) for 2008 by marrying and filing a joint return. b. Presuming no marriage and using the rate schedules for 2008 applicable to single persons, Addison’s tax on $50,000 (taxable income) is $4,481.25 + 25%($50,000 – $32,550) = $8,843.75, or $8,844 (rounded). Corey’s tax is $0. If Cory and Addison marry and file a joint return, the following takes place: Addison’s wages Corey’s wages AGI Standard deduction (married persons filing jointly) Personal exemptions ($3,500 2) Taxable income $58,950 2,000 $60,950 (10,900) (7,000) $43,050
Tax on $43,050 using the rate schedule for married persons filing jointly is $1,605 + 15%($43,050 – $16,050) = $5,655. By comparing the $8,844 Addison would pay (and Corey’s $0 tax) if they do not marry with the $5,655, the parties would save $3,189 by marrying and filing jointly for 2008. 49. pp. 3-29 and 3-30 a. For year 2007, Jerrod can use married filing joint status. Because he is the executor of the estate, he can make the election to file jointly on Nadia’s behalf. He can claim Macy as a dependent since she is a qualifying child. As such, her gross income is immaterial. b. For year 2008, Jerrod must file as a single individual. He cannot be a surviving spouse as Macy is not his dependent. She is not a qualifying child due to the age test, and she is not a qualifying relative due to the gross income test. Jerrod cannot be a head of household for the same reason—Macy is not a dependent. c. For 2009, Jerrod qualifies for surviving spouse filing status. Macy now comes under the qualifying child category and is Jerrod’s dependent. Although she is not under age 19, she is under age 24 and a full-time student. Thus, her gross income makes no difference.
Concept Summary 3-1 and Example 38 a. Olivia has the following results:
LTCG (land) STCL (IBM) STCG (boat and trailer) Loss on camper (nondeductible)
$4,000 (1,000) 2,000 –0–
Thus, she has a net LTCG of $4,000 and a net STCG of $1,000. Her tax is $930 [($4,000 15%) + ($1,000 33%)]. b. c. 53. $150 [($4,000 0%) + ($1,000 15%)]. $350 [($4,000 5%) + ($1,000 15%)].
pp. 3-33 and 3-34 a. By concentrating the payment of three years of charitable contributions (2007, 2008, and 2009) into one year (2008), this will allow the Hundleys to itemize their deductions from AGI in 2008. Otherwise their itemized deductions (normally $9,500) are of no benefit, as they do not exceed the standard deduction ($10,700 for 2007 and $10,900 for 2008). b. Presuming the $9,500 of normal itemized deductions already includes one year of church pledge payments, the additional payment of $7,200 ($3,600 for 2007 and $3,600 for 2009) yields itemized deductions of $16,700 ($9,500 + $7,200) for 2008. This exceeds the standard deduction that would have been claimed by $5,800 ($16,700 – $10,900). Therefore, the tax savings by concentrating the charitable contributions becomes $1,450 (25% × $5,800). The same tax that would have been paid will result for 2007 and 2009 as the standard deduction is claimed for each of these years.
Examples 50 and 51 Interest income (Note 1)— CD Loan to Larry Inman (Note 2) Church raffle (Note 3) Property transactions— Garage sale (Note 4) City lot (Note 5) IRA contributions (Note 6) AGI (Note 7) Itemized deductions (Note 8) Personal exemptions ($3,400 2) Dependency exemptions—(Note 9) ($3,400 4) Taxable income Tax on $47,914 from Tax Table Less withholdings ($3,500 + $3,000) Net tax payable (or refund due) Notes (1) Interest of $410 on City of Orlando bonds is an exclusion from gross income.
$850 500 $ –0– (2,000)
1,350 3,500 (2,000) (8,000) $84,850 (16,536) (6,800) (13,600) $47,914 $6,406 6,500 ($ 94)
(2) (3) (4)
Of the $5,500 received from Larry Inman, $5,000 is a nontaxable return of capital and $500 is taxable interest income. The church raffle is a taxable prize. Since cash of $3,500 was an option, it can be assumed that the ATV is worth the same amount. The garage sale generated a realized loss of $3,900 [$5,000 (basis) – $1,100 (sale proceeds)]. Because the loss is on personal use property, none of it can be recognized. The sale of the lot results in a realized loss of $2,000 [$11,000 (basis) – $9,000 (sale proceeds)]. As up to $3,000 of excess capital losses can be deducted against regular income, the full $2,000 is allowed. Contributions to traditional IRAs are classified as deductions for AGI. The $24,000 gift from Paula’s parents is a nontaxable exclusion. Itemized deductions are determined as follows: Medical expenses Less (7.5% $84,850) Taxes ($3,100 + $3,700) Interest Charitable contributions Total $9,500 (6,364) $ 3,136 6,800 4,200 2,400 $16,536
(6) (7) (8)
Robert, Helen, and Elizabeth meet the qualified child definition. Consequently, Helen and Elizabeth are not subject to a gross income test as to their earnings. Cecelia can be claimed under a multiple support agreement.
See the completed tax return beginning on page 3-23 of this Solution Manual. 55. Part 1— Tax Computation Salary Interest income (Note 1)— General Electric Corporation bonds Wachovia Bank CD AGI (Note 2) Itemized deductions (Note 3) Personal exemption (1 × $3,400) Dependency exemptions (Note 4) Taxable income $59,000 $1,800 3,100 4,900 $63,900 (10,807) (3,400) (13,600) $36,093 $ 4,629 (4,800) ($ 171)
Tax from Tax Table (Note 5) Less withholdings and 2006 overpayment ($4,400 + $400) Net tax payable (or refund due) Notes (1) (2)
Interest of $7,000 on City of Denver bonds is excluded from gross income. The life insurance proceeds of $200,000, personal injury award of $250,000, and inheritance of $185,000 are exclusions from gross income. As Betty acted as her own counsel, no attorney’s fees were incurred in the ski-lift negotiations and need not be accounted for. Itemized deductions: Medical expenses Less (7.5% × $63,900) Property taxes on home State and local sales taxes Interest on home mortgage Charitable contributions Total itemized deductions $5,200 (4,793) 407 1,900 3,200 4,200 1,100 $10,807 $
Betty will itemize because these deductions ($10,807) exceed the standard deduction ($10,700). (4) Due to age limitations (19 or over), none of Betty’s children meet the qualifying child definition of a dependent. However, all satisfy the qualifying relative definition. This also is the case with Betty’s father, Alan. Betty is a surviving spouse and can use the income tax rates applicable to married persons filing a joint return.