Chapter 17 - Tax Consequence s of Personal Activities

Chapter17

QuestionsandProblemsforDiscussion

1. Thebasicincomerecognitionruleisthatincomefromwhateversourcederivedissubjecttotax.
Underthisinclusiverule,incomefrompersonalactivitiesisjustastaxableasincomefrom
business,employment,orinvestmentactivities.Incontrast,thebasicruleregardingpersonal
expensesandlossesisthattheyarenondeductible.

2. Giftsandinheritancesusuallyrepresentintrafamilytransfersofwealth.Becausetheaggregate
wealthofthefamilyasasocialunitdoesnotincrease,thegiftorinheritancedoesnotrepresent
economicincome.Asecondrationaleisthatgiftsandinheritancesrepresentaftertaxincomeof
thedonorordecedent,andprivatetransfersofsuchaftertaxincometolovedonesshouldnot
betaxedasecondtime.Finally,arequirementthatdoneesandbeneficiariesreportthevalueof
giftsandinheritancesastaxableincomewouldbeextremelydifficultfortheIRStoenforce.

3. First,custodialparentsdonotincludechildsupportpaymentsfromnoncustodialparentsin
taxableincome.Second,custodialparentsmayqualifytofiletheirtaxreturnsasheadsof
householdratherthansingleindividuals.Third,custodialparentscanclaimanexemptionand
childcreditforeachchildunlesstheygranttheexemptionandcredittothenoncustodialparent.

4. Welfarepaymentsarebasedonfinancialneedoftherecipient.Therefore,therecipient,by
definition,hasminimalabilitytopaytax.Incontrast,unemploymentbenefitsarenotbasedon
financialneedoftherecipientanddonotsuggestthattherecipienthasareducedabilitytopay
tax.

5. Onlyindividualswhopaidemployeepayrolltaxorselfemploymenttaxduringtheirworking
yearsareeligibletoreceiveSocialSecurity.Manypeoplebelievethattheseemploymenttax
paymentsconstitutetheirpersonalinvestmentintheSocialSecuritysystemamandatory
savingsaccounttowhichtheyareentitledwhentheyretire.Inotherwords,theircurrentSocial
Securitybenefitsaresimplyareturnoftheiraftertaxcontributionsandshouldnotbetaxeda
secondtime.

6. Theannualpremiumtocarryinsuranceonbusinesspropertyisanexpensethatmustbe
deductedagainstgrossrevenuestoproperlymeasurenetbusinessincome.Incontrast,the
annualpremiumtocarryhomeownersinsuranceisanonbusiness,personalexpense.

7. Mr.Coxcouldarguethathisstampcollectionisaninvestmentasset,andthe$25monthly
chargeforasafetydepositboxisaninvestmentexpenseallowableasamiscellaneousitemized
deduction.Thealternativeisthatthecollectionisapersonalasset,andthemonthlychargeisa
nondeductiblepersonalexpense.

8. Thischangeinthetaxlawwouldincreasetheaftertaxcostofcharitablecontributions
dramatically.Consequently,peoplemightdecreasetheleveloftheircharitablecontributionsand
charitiesmightbeforcedtocutback,oreveneliminate,theservicesprovidedtothepublic.In
suchcase,peoplethatenjoyedorbenefitedfromtheservicesbeartheincidenceofthetax
increaserepresentedbythereducedcharitablecontributiondeduction.

9. Peoplewhosellusedpersonalitemsatgaragesalestypicallyrealizeanondeductibleloss
(excessofcostoveramountrealizedonsale).Thus,thecashreceivedonsaleisanontaxable,
partialreturnoftheoriginalcostoftheitem.

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10. TheBurtonfamilyhaslessAGIthantheAwadfamily.Thus,theBurtonfamilysunreimbursed
medicalexpensesexceeded7.5percentofAGIby$6,000,whiletheAwadfamilys
unreimbursedmedicalexpenseswerelessthan7.5percentofAGI.

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11. Acharitablecontributionmadeduringlifereducesthedonorsaccumulatedwealth(potential
taxableestate)andalsogeneratesanincometaxdeductionfortheyear.Acharitable
contributionmadeatdeaththatreducesthedecedentstaxableestatedoesnotresultinan
incometaxdeductionforanyone.

12. No.AlthoughtherevenuefromMrs.Lelandshobbyistaxableincome,itisnotearnedincome
fromselfemployment.

13. Thehobbylossruleandthevacationhomerulelimitthedeductionforexpensesassociatedwith
apersonalactivityorresidencetotherevenuegeneratedbysuchactivityorresidence.
However,expensesdeductibleunderthehobbylossrulearemiscellaneousitemized
deductions,subjecttofurtherlimitation,whileexpensesdeductibleunderthevacationhomerule
areabovethelinedeductions.

ApplicationProblems

1. a. NotincludedinMarcysAGI.
b. $500includedinMarcysAGI.
c. $8,000includedinMarcysAGI.
d. NotincludedinMarcysAGI.

2. Salary $4,200
Scholarshippaymentsforroomandboard 10,000
Ms.QueensAGI $14,200

3. Lylemayexcludethe$600,000paymentreceivedascompensationforhisphysicalinjuriesfrom
income.Theremaining$1,150,000paymentistaxableincome.

4. a. Annmustincludetheentire$12,000alimonypaymentinAGI.
b. Annmustinclude$7,200alimony($60012months)inAGI.
c. Anndoesnotincludeanyofthe$12,000giftinAGI.

5. a. Willdoesnotrecognizeanyincomeonreceiptofthesecurities.
b. Willrecognizesa$85,450gainonsaleofthesecurities($175,250amountrealized
$89,800carryoverbasisfromSandra).
c. Sandradoesnotrecognizeanygainontransferofthesecurities.

6. Mr.Lynchsonlytaxableincomeitem(andhisAGI)ishis$9,279unemploymentcompensation.

7. SocialSecuritybenefit($26,89085%) $22,857
Dividendsandinterest 78,600
Taxablepensions 62,900
Mr.andMrs.NestersAGI $164,357

8. Mrs.Smallsonlytaxableincomeitem(andherAGI)isher$10,800pension.BecauseherAGIis
solow,noneofherSocialSecuritybenefitistaxable.

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9. a. Becausetheunreimbursedmedicalexpensesarenotdeductibleabovetheline,theirafter
taxcostis$11,340.
b. Ms.Lincolnsmedicalexpensedeductionis$7,717($11,340$3,623[$48,300AGI
7.5%]),andhertaxsavingsfromthedeductionis$1,929($7,71725%).Theaftertaxcost
oftheexpensesis$9,411($11,340$1,929).
c. Ms.Lincolnsmedicalexpensedeductionis$1,792($11,340$9,548[$127,300AGI
7.5%]),andhertaxsavingsfromthedeductionis$502($1,79228%).Theaftertaxcostof
theexpensesis$10,838($11,340$502).

10. a. Unreimbursedmedicalexpenses $2,215

AGIthreshold($25,000 7.5%) (1,875)
Mr.andMrs.Mosssitemizeddeduction $340

b. Unreimbursedmedicalexpenses $2,215
AGIthreshold($50,000 7.5%) (3,750)
Mr.andMrs.Mosssitemizeddeduction 0

11. Mr.Pappcandeductthe$4,200paymenttohisCPAasamiscellaneousitemizeddeductionon
ScheduleA.Hecanalsoclaimmiscellaneousitemizeddeductionsforthe$900paymenttohis
CPAforpreparationofagifttaxreturnandthe$3,000paymenttohisattorneyforestate
planningadvice.Theotherpaymentstohisattorneyarenondeductiblepersonalexpenses.

12. Mr.Curtisisallowedanitemizeddeductionforhis$3,710stateincometax(becauseitexceeds
his$2,040salestax)andhis$7,500totalpropertytaxpayments.Theothertaxpaymentsare
nondeductible.

13. a. Becausethepropertytaxpaymentsarenotdeductibleabovetheline,theiraftertaxcostis
$6,438.
b. Perrystaxsavingsfromhisdeductionis$2,125($6,43833%),sotheaftertaxcostofthe
propertytaxpaymentsis$4,313($6,438$2,125).
c. BecausethepropertytaxpaymentsarenotdeductibleincomputingAMTI,theiraftertax
costis$6,438.

14. a. Becausethecharitablecontributionisnotdeductibleabovetheline,Maryhasnotax
savingsfromthecontribution.
b. Marystaxsavingsfromhercontributionis$1,275($8,500FMV15%).
c. Marystaxsavingsfromhercontributionis$2,975($8,500FMV35%).

15. a. The$2,000cashpaymentisdeductible.
b. The$50cashpaymentisnondeductiblebecausetherecipient(thevagrant)isnotaqualified
charity.
c. Becausethepaintingisaninventoryitemratherthanacapitalasset,Dianesdeductionis
limitedtoherbasisintheitem,whichiszero.
d. The$10,000politicalcontributionisnondeductible.
e. BecausethehouseholdfurnitureisacapitalassettoDiane,shecanclaimthe$1,200FMV
asacontributiondeduction.

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16. Cash Securities

Costbasisofcontribution $500,000 $318,000
Unrealizedappreciation 182,000
Beforetaxcostofcontribution(FMV) $500,000 $500,000
Taxavoidedonunrealizedappreciation(15%$182,000) (27,300)
Taxsavingsfromdeduction(35%$500,000) (175,000) (175,000)
Ms.Princesaftertaxcostofcontribution $325,000 $297,700

17. TheadditionalAGIwillreducethemedicalexpensedeductionby$1,500($20,000additional
AGI7.5%),thecasualtylossdeductionby$2,000($20,000additionalAGI10%),andwill
eliminatethemiscellaneousitemizeddeductions($20,000additionalAGI2%=$400
reduction).TheadditionalAGIwillhavenoeffectonthestateandlocaltaxdeductionorthe
charitablecontributiondeduction.

18. a. Miltrealizedan$11,700nondeductiblelossonthesaleofapersonalasset.
b. Miltrealizeda$15,000longtermcapitalgain(collectiblesgain)taxedatamaximumrateof
28percent.

19. AssumingthatConradcollectsthecomicbooksprimarilyforfunratherthanforprofit,the$3,075
capitalgainrealizedonsaleoftheSupermancomicisincludedinAGI,whilethe$325loss
realizedonsaleoftheDonaldDuckcomicisanondeductiblepersonallossthathasnoeffecton
AGI.IfConradcouldsustainanargumentthathiscollectingactivityisprimarilyforinvestment
purposes,hecouldrecognizedthelossasacapitalloss.

20. a. Mrs.Carrhasanitemizeddeductionfor$21,000qualifiedresidenceinterestonher
acquisitiondebt.
b. Mrs.Carrhasanitemizeddeductionfor$3,000qualifiedresidenceinterestonherhome
equitydebt.
c. Nodeduction.
d. Mrs.Carrcandeductthe$15,000interestasabusinessexpenseonScheduleC.
e. Nodeduction.
f. Mrs.Carrisallowedanitemizeddeductionfor$1,750investmentinterestbecauseshe
recognizedmorethan$1,750investmentincomethisyear.

21. Wallet Automobile Trees

LesserofbasisordecreaseinFMV $900 $24,000 $6,100*
Insurance 0 (17,500) 0
Unreimbursedloss $900 $6,500 $6,100
$100floorpercasualty (100) (100) (100)
$800 $6,400 $6,000
* ThedecreaseinvalueinMs.Whitespersonalresidencecanbemeasuredbythe
replacementcostoftheornamentaltrees.
a. Aggregateloss $13,200
AGIthreshold($53,000 10%) (5,300)
Ms.Whitesitemizeddeduction $7,900
b. Aggregateloss $13,200
AGIthreshold($210,000 10%) (21,000)

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Ms.Whitesitemizeddeduction 0

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22. a. AlthoughMr.andMrs.Valerealizeda$111,000gainontheinvoluntaryconversion,theydo
notrecognizeanygainbecausetheyreplacedthepaintingwithanassetsimilarorrelatedin
serviceoruse.Thus,theyhavenotaxconsequencesfromthetheft.
b. Inthiscase,Mr.andMrs.Valemustrecognizea$111,000capitalgainandpaytax
accordingly.
c. Mr.andMrs.Valehavea$38,900casualtyloss($39,000unreimbursedloss$100floor).
Theiritemizeddeductionforthislossis$26,400($38,900casualtyloss[10%$125,000
AGI]).
d. Mr.andMrs.Valehavea$88,900casualtyloss($89,000unreimbursedloss$100floor).
Theiritemizeddeductionforthislossis$76,400($88,900casualtyloss[10%$125,000
AGI]).

23. a. The$5,800revenuegeneratedbyMrs.HessshobbyinincludedinAGIasmiscellaneous
income.Becauseshedoesnotitemizedeductions,herhobbyrelatedexpensesare
nondeductible.Consequently,herhobbygenerates$5,800taxableincome.
b. Becauseherhobbyrelatedexpensesarelessthanherrevenue,Mrs.Hessisalloweda
$1,040miscellaneousitemizeddeduction($1,700$660[$33,000AGI2%[).
Consequently,herhobbygenerates$4,760taxableincome.

24. a. Grossrevenuesfrompaintingbusiness $13,290

Businessexpenses (8,250)
ScheduleCnetprofitincludedinAGI $5,040

b. UnlessMr.MonkcanconvincetheIRSthathehasanactualandhonestobjectiveofmaking
aprofit,hispaintingactivityisahobby.Consequently,hemustincludehis$2,000incomein
AGIandreport$2,000ofhisexpensesasamiscellaneousitemizeddeduction.

c. EventhoughMr.Monkdidnotshowaprofitthisyear,thefactthathispaintingactivitywas
profitableinthreeofthelastfiveyearscreatesapresumptionthattheactivityisabusiness.
Grossrevenuesfrompaintingbusiness $2,000
Businessexpenses (8,250)
ScheduleCdeductiblelossincludedinAGI $(6,250
)

25. a. Theitemizeddeductionis$5,830becausetheaveragebalanceofthehomeequitydebtis
lessthan$100,000.
b. Theitemizeddeductionis$6,485([$100,000$162,000averagebalanceofhomeequity
debt]$10,506interestpayment).
c. Theitemizeddeductionis$10,506becausethemortgagequalifiesasacquisitiondebtand
theaveragebalanceislessthan$1million.

26. Mr.andMrs.Kimhave$37,853qualifiedresidenceinterestcomputedasfollows.
Averagebalanceofacquisitiondebt $641,800
Averagebalanceofhomeequitydebt(limited) 100,000
Qualifyingdebt $741,800
($741,800qualifyingdebt$981,800totaldebt)$50,100totalinterest=$37,853

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27. a. Ms.Imorealizeda$93,500gain($178,500amountrealized$85,000costbasis)onthe
2000saleandexcludedtheentiregainfromincome.Sherealizeda$315,000gain
($700,000amountrealized$385,000costbasis)onthecurrentyearsale.Sheexcluded
$250,000gainfromincomeandrecognized$65,000taxablegain.
b. Ms.Imos$65,000taxablegainislongtermcapitalgain,andhertaxis$9,750($65,000
15%).

28. a. Mr.andMrs.Nixonmeettheownership/userequirementandthereforemayexcludethe
entire$278,000gainrealizedonsaleoftheirformerresidencefromtaxableincome(i.e.,
theyrecognizenogainonthesale).
b. BecauseMr.andMrs.Nixonsoldthenewresidencewithintwoyearsofthesaleoftheir
formerresidence,theymustrecognizetheir$48,000realizedgainaslongtermcapitalgain.
c. Inthiscase,Mr.andMrs.Nixonsoldtheirnewresidencebecauseofachangeinplaceof
employment.Thus,theyareeligibleforareducedexclusioncomputedasfollows.
$500,000 629days*=$430,822reducedexclusion
730days
*timeperiodbetweenJune7,2005,saleandFebruary26,2007,sale

Consequently,Mr.andMrs.Nixonrecognizenogainonthesaleofthenewresidence.

29. a. Mrs.Gomezrealizedan$8,000nondeductibleloss.
b. Mrs.Gomezrealizeda$114,500gain($262,500$148,000),allofwhichshemayexclude
fromtaxableincome.
c. Mrs.Gomezrealizeda$319,000gain($467,000$148,000),$250,000ofwhichshemay
excludefromtaxableincomeand$69,000ofwhichshemustrecognizeaslongtermcapital
gain.

18. Mr.andMrs.BoazsAGI $109,300

Itemizeddeductions (18,523)
Exemptionamount($3,4006) (20,400)
Taxableincome $70,377
Regulartaxon$70,377(MFJ) $10,442

AMTcalculation:
Taxableincome $70,377
Disallowedstateincometaxdeduction 6,925
Disallowedpropertytaxdeduction 4,122
Disallowedhomeequityloaninterest 1,377
Disallowedmiscellaneousitemizeddeductions 769
Disallowedexemptionamount 20,400
AMTIbeforeexemption $103,970
Exemption(MFJ) (62,550)
TaxableAMTI $41,420
.26
Tentativeminimumtax $10,769
Regulartax (10,442)
AMT $327

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IssueRecognitionProblems

1. DoesMr.Jrecognize$5,000taxableincomeonreceiptofarewardreceivedforpublicservice?

2. IsthebriefcaseanontaxablegiftortaxablecompensationtoMr.SA?

3. HowmuchtaxableincomedoesMr.TLrecognizebecauseofthereceiptofthevacuumcleaner?
IsMr.TLstaxableincomemeasuredbythe$365retailvalueofthevacuumcleanerorbythe
$275garagesaleprice?

4. Isthe$2,700strikebenefitanontaxablegifttoMs.BGfromherfellowpilots,orisittaxable
incomepaidtoherwithrespecttoheremployment?

5. Isthe$15,000cashreceiptanontaxablescholarshiporataxableprizetoMs.LS?

6. DidMr.UWrecognize$11,500taxableincomebecauseherecoveredtheswordandestablished
alegalclaimtoit?CanMr.UWdeferincomerecognitionuntilhesellstheswordforcash?

7. CanMrs.OPexcludethe$300,000receiptfromtaxableincomebecausethedamages
representedcompensationforpsychologicalandcivilinjury?

8. DoesanyportionofZacharysmonthlypaymentconstitutechildsupport(nondeductibleby
Zachary/nontaxabletoStella)ordoestheentirepaymentqualifyasalimony(deductibleby
Zachary/taxabletoStella)?

9. CanMrs.Nrecovertheentire$3,200costofthecomputerasabusinessdeduction,even
thoughherchildrenuseitforpersonalreasons?BywhatmethodcanMrs.Nallocatethecostof
thecomputerbetweenbusinessandpersonaluse?

10. Doesthe$8,900costofMrs.VVsfaceliftqualifyasadeductiblemedicalexpense?

11. Doesthe$25,000costofMr.Sslappoolqualifyasadeductiblemedicalexpense?

12. DoMrs.PMstravelcosts(gas,meals,lodging)qualifyasdeductiblemedicalexpenses?

13. CanMr.Rclaiman$18,000contributiondeductionfortheannualvalueoftheprofessional
servicehedonatestothelocalcharity?

14. CanMr.andMrs.FPclaima$500contributiondeductionbecausetheirmotiveinmakingthe
paymentwastobenefitacharitableorganizationratherthantoobtainthecookies?

15. CanMs.DSclaimacasualtylossdeductionbecauseshemisplacedorlostherdiamondring?

16. DoestheentireacreagequalifyasMr.Dspersonalresidenceormusthetreatsomeportionof
thelandasaninvestmentasset?DoesMr.Dsentire$600,000debtqualifyashomeacquisition
debtsothathecandeducthisinterestpayments?MustMr.Dclassifysomeportionofhis
interestonthedebtasinvestmentinterest?

17. Canasailboatqualifyasaprincipalresidence?CanMr.Ydeferhis$79,000realizedgainonthe
saleofhishomebecausehepurchasedthesailboat?

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18. CanMs.SEdeductherentire$24,700realizedlossasaSection1231ordinarylossinthe
computationofAGI?Is$15,000ofMs.SEsrealizedloss(declineinvaluethatoccurredbefore
sheconvertedthehousetorentproperty)anondeductiblepersonalloss?

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19. CanMr.andMrs.AQdeductthe$1,700legalfeeasaninvestmentexpense?Canthey
capitalizethe$1,700feetotheirbasisinthepersonalresidence?

ResearchProblems

1. InRev.Rul.979,19971CB77,theInternalRevenueServiceruledthatanyamountpaidfora
controlledsubstance(suchasmarijuana)inviolationoffederallawisanondeductiblemedical
expense.
2. Accordingto.Reg.Sec.1.621T(d),expensesdirectlyconnectedwiththeconductofatradeor
businessaredeductibleinthecomputationofAGI.Taxespaidbyanindividualaredeductibleas
businessexpensesonlyiftheyaredirectlyattributabletotheconductofabusiness.However,
theregulationspecificallystatesthatstatetaxesonnetincomearenotdeductible[incomputing
AGI]eventhoughthetaxpayersincomeisderivedfromtheconductofatradeorbusiness.
Basedonthisregulatoryauthority,Mr.andMrs.LukertmustreporttheirMassachusettsincome
taxasanitemizeddeductiononScheduleA.
3. Section280A(g)providesaspecialsetofrulesifanindividualrentsoutapersonalresidencefor
lessthan15daysduringataxableyear.Inthecaseofsuchdeminimisrentaluse,theindividual
doesnotincludetherentalrevenueingrossincomeandisnotallowedtodeductanyexpenses
relatedtotherentalperiod.TheLorchsrentedouttheirapartmentfor11daysinoneyearand
11daysinthenext.Thus,theyarenotrequiredtorecognizethe$11,000rentastaxable
income,andtherentalarrangementhasnotaxconsequences.
4. ThisresearchproblemisbasedonthefactsinTAM199945008(July12,1999).Accordingto
theIRS,theamountrealizedbyanindividualonthesaleofhisrighttoreceiveastreamoffuture
lotterywinningswasordinaryincomeandnotcapitalgain.Althoughtherighttotheannuitymet
thedefinitionofacapitalasset,theIRSconcludedthatpaymentfortheannuitywasasubstitute
forfutureordinaryincomeandshouldbetaxedaccordingly.Consequently,BarrySheltonmust
recognize$1.79millionordinaryincomeonthesaleofhisrighttotheguaranteedannuity.See
alsoUnitedStatesv.Maginnis,356F.3d1179(CA9,2004).
5. BecauseHowardssecondsalewouldoccurwithtwoyearsofhisfirstsaleofaprincipal
residence,hewillnotbeallowedtoexcludeanygainrealizedunlessthereasonforthesecond
saleisachangeinplaceofemployment,health,or,totheextentprovidedinregulations,
unforeseencircumstances.(Section121(c)(2)(B))InLtr.Rul.200403049,theIRSruledthatthe
threatsofhostileneighborsconstitutedanunforeseencircumstancewithinthemeaningofthe
statute.Basedinthisruling,Howardwillbeentitledtoapartialexclusion(basedonthenumber
ofdaysbetweenthetwosalesasprovidedinSection121(c)(1)).

TaxPlanningCases

1. a. Byrefusingcompensationforherservicesbutaskingtheuncletonameherasabeneficiary
underhiswill,Ms.JHmayhaveconverted$100,000taxableincometoa$100,000
nontaxableinheritance.
b. TheopportunitycostisthedelayofMs.JHsreceiptof$100,000untilherunclesdeath.The
riskisthattheunclewillchangehismindandwriteMs.JHoutofthewill(i.e.,deletethe
codicilprovidingforherbequest)beforehisdeath.

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2. a. Mr.TBsannualaftertaxcostofthenondeductiblechildsupportpaymentsis$48,000.Mrs.
TBsaftertaxcashflowisalso$48,000.Becauseshehasnotaxableincome,shehasno
taxsavingsfromtheexemptionsandchildcreditsforherdependentchildren.
b. Underthecounterproposal,Mr.TBsaftertaxcostdecreasesto$43,216
Annualchildsupportandalimonypayments $(55,200)
Taxsavings:
Deductionforalimony($36,00028%) 10,080
Twoexemptions($6,80028%) 1,904
Aftertaxcost $(43,216)
(NotethatMr.TBhastoomuchincometotakeachildcreditforhisdependentchildren.)

Mrs.TBsaftertaxcashflowincreasesto$52,047.
Annualchildsupportandalimonypayments $55,200
Taxcost:
Taxablealimony $36,000
Standarddeduction (7,850)
Mrs.TBsexemption (3,400)
Taxableincome $24,750
Taxon$24,750(HH) (3,153)
Aftertaxcashflow $52,047

3. Mr.andMrs.JMmayhaveconvertedanondeductiblepersonalexpense($4,950charitable
contributiontoStateUniversity)toadeductiblebusinessexpense($4,950advertisingforthe
ShorelineGrill).

4. IfMr.Zbuysthemutualfundshares,hisannualaftertaxcashflowwillincreaseby$2,211
($3,300beforetaxincome$1,089taxcost).IfMr.Zpaysoffhispersonaldebt,hisannual
aftertaxcashflowwillincreaseby$2,350(nondeductibleinterestpayments).IfMr.Zpaysdown
hishomemortgage,hisannualaftertaxcashflowwillincreaseby$1,943($2,900decreasein
interestpayments$957taxsavingsfromitemizeddeduction).Basedonthesecomparisonsof
aftertaxcashflow,Mr.Zshouldpayoffhispersonaldebt.

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ComprehensiveProblemsforPartFive

1. Mr.Meyerssalary($70,000$6,300Section401(k)) $63,700
Mrs.Meyerssalary 29,400
Mrs.MeyersshareofScorporationincome 13,790
Mrs.Meyersshareofrentalrealestateloss* (8,100)
Lotterywinnings 6,400
Qualifyingdividenddistribution 712
Capitalgaindistribution 3,020
Alimonypaid (12,000)
Adjustedgrossincome(AGI) $96,922
* The$8,100rentalrealestatelossispassive.TheMeyersAGIbeforeanyrentallossdeductionis$105,022.
Therefore,theyareentitledtoa$22,489rentalrealestateexception($25,000[50%$5,022excessAGIover
$100,000]).Consequently,theentirelossisdeductible.

Itemizeddeductions: Homemortgageinterest (14,200)

Propertytax (2,780)
Stateincometax (7,000)
Charitablecontributions (1,945)
Exemptionamount($3,400 3) (10,200)
Taxableincome $60,797
Taxon$57,065ordinarytaxableincome(MFJ) $7,777
Taxon$3,732dividendsandLTCG(5%) 187
Precredittax $7,964
Childcredit (1,000)
Mr.andMrs.Meyersregularincometax $6,964

AMTcalculation:
Taxableincome $60,797
Disallowedpropertytaxdeduction 2,780
Disallowedstateincometaxdeduction 7,000
Disallowedexemptionamount 10,200
AMTIbeforeexemption $80,777
Exemption(MFJ) (62,550)
AMTI $18,227

AMTonordinaryAMTI($14,49526%) $3,769
AMTondividendsandLTCG($3,7325%) 187
Tentativeminimumtax $3,956

Mr.andMrs.MeyersdonotoweAMTbecausetentativeminimumtaxislessthanregular
incometax.

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2. Mrs.Yankssalary $38,400
Insurancesettlement $25,000
Compensationforphysicalinjury (20,000)
Taxableportionofsettlement 5,000
Unemploymentcompensation 1,400
Interest 629
Alimonyreceived 1,600
DeductibleIRAcontribution (800)
Adjustedgrossincome(AGI) $46,229
Standarddeductionforheadofhousehold (7,850)
Exemptionamount($3,400 2) (6,800)
Taxableincome $31,579
Precredittax(HH) $4,177
Dependentcarecredit($1,300 20%) (260)
Childcredit (1,000)
Mrs.Yanksregularincometax $2,917
Incometaxwithholding (3,412)
RefundduetoMrs.Yank $(495)

AMTcalculation:
Taxableincome $31,579
Disallowedstandarddeduction 7,850
Disallowedexemptionamount 6,800
AMTIbeforeexemption $46,229
Exemption(HH) (42,500)
AMTI $3,729
.26
Tentativeminimumtax $970

Mrs.YankdoesnotoweAMTbecausetentativeminimumtaxislessthanregularincometax.

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 Chapter 17 - Tax Consequence s of Personal Activities
3. Mr.Bensonsshareofpartnershipincome $278,300
Interestincome 10,365
Qualifieddividendincome 13,790
Capitalgaindistribution $4,218
Capitallosscarryforward (9,723)
Netcapitalloss (5,505) (3,000)
Passiveactivityloss(minkfarm) 0
OnehalfSEtaxof$19,5431 (9,772)
Unreimbursedmovingexpense (1,260)
DeductibleKeoghplancontribution (28,500)
Adjustedgrossincome(AGI) $259,923
Itemizeddeductions2 (68,229)
Exemptionamount(seeworksheet) (14,505)
Taxableincome $177,189
Taxon$163,399ordinarytaxableincome(MFJ) $34,744
Taxon$13,790dividends(15%) 2,069
Mr.andMrs.Bensonsregularincometax $36,813

AMTcalculation:
Taxableincome $177,189
Disallowedinterestonhomeequitydebt 4,120
Disallowedpropertytaxdeduction 8,400
Disallowedsalestaxdeduction 1,911
Reversalofreductioninitemizeddeductions (2,072)
Exemptionamount 14,505
AMTIbeforeexemption $204,053
Exemption($62,550(25%[$204,053$150,000]) (49,037)
AMTI $155,016

AMTonordinaryAMTI($141,22626%) $36,719
AMTondividends($13,79015%) 2,069
Tentativeminimumtax $38,788
Regularincometax (36,813)
AMT $1,975
Regularincometax $36,813
AMT 1,975
Mr.BensonsSEtax 19,543
Totaltax $58,331
Estimatedtaxpayments (58,000)
Mr.andMrs.Bensonsbalanceoftaxdue $331

1
SEtaxcalculationon$257,010netearningsfromselfemployment:
SocialSecuritytax($97,500 12.4%) $12,090
Medicaretax($257,010 2.9%) 7,453
SEtax $19,543

2
Mortgageinterestonacquisitiondebt $33,890
Mortgageinterestonhomeequitydebt 4,120
Propertytaxdeduction 8,400
Salestaxdeduction 1,911
Charitablecontributiondeduction 21,980
Taxpreparationfee $3,350

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Chapter 17 - Tax Consequence s of Personal Activities
2%AGIthreshold (5,198)
Miscellaneousitemizeddeduction 0
Totalitemizeddeductions $70,301
Itemizeddeductionsallowed(seeworksheet) $68,229

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 Chapter 17 - Tax Consequence s of Personal Activities
ItemizedDeductionWorksheet

Maximumreduction
TotalitemizeddeductionslistedonScheduleA 70,301
Lessdeductionsfor: medicalexpense 0
investmentinterestexpense 0
casualty,theft,orgamblingloss 0
total 0
Totalitemizeddeductionssubjecttooveralllimitation 70,301
.80
Maximumreduction 56,241
Adjustedgrossincome(AGI) 259,923
2007AGIthreshold (156,400)
ExcessAGI 103,523
.03
3,106
.667
Tentativereduction 2,072

TotalitemizeddeductionslistedonScheduleA 70,301
Lessthesmallerofthemaximumortentativereduction (2,072)
Totalitemizeddeductionsallowed 68,229

ExemptionAmountWorksheet
2007exemption 3,400
Multiplybynumberofexemptions(taxpayersanddependents)
5
Tentativeexemptionamount 17,000

Adjustedgrossincome(AGI) 259,923
2007AGIthresholdformarriedfilingjointly (234,600)
ExcessAGI 25,323

ExcessAGIdividedby$2,500(roundeduptowholenumber) 11
(if50ormore,theexemptionamountis0)
Multiplyby2 2
Percentage(%)reductionintentativeexemptionamount 22

Tentativeexemptionamount 17,000
Percentagereduction .22
Reductioninexemptionamount 3,740
.667
Reductioninexemptionamount 2,495

Exemptionamount(17,0002,495) 14,505

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