AC402 Chapter 6

Vella owns and operates an illegal gambling establishment. In connection with this activity, he has the following expenses during the year: Rent $ ‍24,000 Bribes 40,000 Travel expenses 4,000 Utilities 18,000 Wages 230,000 Payroll taxes 13,800 Property insurance 1,600 Illegal kickbacks 22,000 What are Vella's total deductible expenses for tax purposes?

All ordinary and necessary expenses incurred in operating an illegal business are deductible. Expenses that are in violation of public policy are not deductible (bribes and illegal kickbacks). All other expenses, which total $291,400, are deductible

What is the "actually paid" requirement for the deduction of an expense by a cash basis taxpayer? Does actual payment ensure a deduction? Explain.

Cash basis taxpayers can deduct an expense only when it has been paid with cash or other property. Borrowing the money to pay the expense (or charging it on a bank credit card) constitutes actual payment.

Linda operates an illegal gambling operation. Which of the following expenses that she incurs can reduce taxable income? Bribes paid to city employees. Salaries to employees. Security cameras. Kickbacks to police. Rent on an office. Depreciation on office furniture and equipment. Tenant's casualty insurance. Utilities.

Even though this is an illegal business, expenditures that are ordinary, necessary, and reasonable are deductible. The bribes paid to city employees (a.) and kickbacks to police (d.) are not deductible because they violate public policy. All of the other items are deductible (b., c., e., f., g., and h.).

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 on how they should respond, and identify any relevant tax issues

In prior years, the beach house has been classified as a rental property because the personal use (exactly 14 days) did not exceed the greater of 14 days or 10% of rental days (200 × 10% = 20 days). Thus, if the total available deductions exceeded the rental income, the loss could be deducted on Karen and Andy's tax return. If Sarah is permitted to use the beach house for 7 days, the total personal use days of 21 will exceed the statutory limit of 20 days (i.e., 10% of rental days of 200). In this case, the deductions are permitted only to the extent of the rental income. What needs to be determined are whether the deductions do exceed the rental income and whether Sarah wants to use it for a full 7 days.

In 2018, 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 not be deductible and Susan's expenses might be appropriately classified as deductions for AGI.

Investment expenses associated with rental property or royalty property are deductible for AGI. Investment interest expense is deductible from AGI (but subject to a limitation based on net investment income). All other investment expenses are miscellaneous itemized deductions (and not deductible from 2018 through 2025). Susan evidently has invested in rental or royalty property, whereas Larry has invested in other investment property.

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

Lobbying expenses generally are not deductible. Therefore, if Melissa pays the $1,500 to a professional lobbyist, the payment is not deductible. However, a de minimis exception provides that inhouse lobbying expenditures not exceeding $2,000 per year can be deducted. Thus, if Melissa spends the $1,500 on in-house lobbying expenditures, she can deduct this amount. Note that if the in-house expenditures had exceeded $2,000, none of the in-house expenditures could have been deducted

Maud, a calendar year taxpayer, is the owner of a sole proprietorship that uses the cash method. On February 1, 2018, 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 2018 tax return?

Maud can deduct $120,000 in 2018 for the rent for February 2018 through July 2019. She does qualify under the one-year rule for prepaid expenses because the period for which prepayments have been made does not extend past December 31, 2019.

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 for 2018?

Nanette is eligible to deduct the charitable contributions of $800 and the personal property taxes of $240 as itemized deductions (deductions from AGI). However, because the standard deduction for 2018 of $12,000 is greater than her itemized deductions of $1,040, she should claim the standard deduction. In addition, she is allowed the $225 under the teacher's professional development and supplies provision as a deduction for AGI.

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.

No, Clear cannot deduct the fines because they are payments in violation of traffic laws.

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?

No, a deduction is not permitted for political contributions.

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.

No. Legal fees incurred in connection with a criminal defense are generally deductible only if the crime is associated with the taxpayer's trade or business or income-producing activity. Because Stuart does not satisfy this requirement, the attorney's fee is not deductible.

Monique 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?

Rental income and expenses are reported on Schedule E (Supplemental Income or Loss) of Form 1040

Stanford owns and operates two dry cleaning businesses. He travels to Boston to discuss acquiring a restaurant. Later in the month, he travels to New York to discuss acquiring a bakery. Stanford does not acquire the restaurant but does purchase the bakery on November 1, 2018. Stanford incurred the following expenses: Total investigation costs related to the restaurant $28,000 Total investigation costs related to the bakery 51,000 What is the maximum amount Stanford can deduct in 2018 for investigation expenses?

Since Stanford is not in the restaurant business and he does not acquire the restaurant, the $28,000 is not deductible. He cannot deduct all of the $51,000 related to the investigation of the bakery since he is not in that trade or business already. Since he did purchase the bakery, the maximum deduction (before amortization) of the $51,000 is $5,000. The $5,000 deduction is reduced dollar for dollar for those expenses in excess of $50,000. $51,000 - $50,000 = $1,000 reduction. $5,000 - $1,000 = $4,000 deduction. The remaining expenses of $47,000 ($51,000 - $4,000) can be amortized over 180 months beginning with the month business begins, which is November. $47,000/180 months = $261 per month. $261 × 2 months = $522. The total deduction is $4,522 ($4,000 + $522).

In the determination of whether a business expense is deductible, the reasonableness requirement applies only to salaries. Evaluate this statement

The statutory language of the Code refers to reasonableness only with respect to salaries and other compensation. However, the courts have held that for any business expense to be ordinary and necessary, it must also be reasonable in amount

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.

The tax consequences to Dave for the residence and the business portions are different. The casualty loss on the residence is a personal loss that is deducted from AGI as an itemized deduction (but only if the casualty relates to a Federally declared disaster area). If this is not the case, then the personal casualty loss is not deductible. No such limitations relate to the casualty loss on the business portion; this loss is a business loss, which is a deduction for AGI

Tobias 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 $ 50,000 Taxable dividends and interest 350,000 How much investment interest can Tobias deduct?

Tobias can deduct only the interest expense attributable to taxable income. The interest attributable to the municipal interest income is not deductible. Thus, only $17,500 ($350,000/$400,000 × $20,000) is deductible.

Michael earned $20,000 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, will a contribution to a traditional IRA reduce his taxable income? Explain.

Yes, the deduction for the traditional IRA contribution will reduce his taxable income. Because the contribution is a deduction for AGI, it reduces his taxable income but has no impact on his itemized deductions. Therefore, his standard deduction will still exceed his itemized deductions and he will continue to use the standard deduction.

Printer Company pays a $25,000 annual membership fee to a trade association for paper wholesalers. The trade association estimates that 60% of its dues are allocated to lobbying activities. What are Printer's total deductible expenses for tax purposes? Assume the same facts as above, except that the $25,000 was incurred for inhouse lobbying expenses. What are Printer's total deductible expenses for tax purposes?

a. $25,000 × 40% = $10,000. b. $0; if in-house lobbying expenditures exceed $2,000, none of the in-house expenditures can be deducted.

Blaze 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 Blaze's investigation of the business. Blaze deducts the $7,000 of expenses. Blaze cannot deduct any of the $7,000 of expenses. Blaze deducts $5,000 of the expenses and amortizes the $2,000 balance over a period of 180 months.

a. Apparently the business being investigated by Blaze was a restaurant. Because Blaze is already in the restaurant business, he can deduct all of the investigation expenses of $7,000 whether or not he acquires a new business. b. Evidently the business being investigated was not a restaurant and Blaze did not acquire the business. Consequently, he is not allowed any deduction for the expenses. c. The business in Columbus being investigated by Blaze was not a restaurant, but Blaze did acquire the business. Therefore, he can take a limited deduction of $5,000 and amortize the balance as startup costs over a 180-month period.

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 Monica Conference registration $ 900 $900 Airfare 1,200 700 Taxi fares 100 -0- Lodging in Dallas 750 300 Amos pays for all of these expenses. Calculate the effect of these expenses on Amos's AGI. Would your answer to part (a) change if the American Bar Association had sponsored the conference? Explain

a. Because Amos pays the expenses related to his tax law practice, he can claim them in calculating AGI. The expenses reduce his AGI by $4,850, determined as follows: Conference registration ($900 + $900) $1,800 Airline tickets ($1,200 + $700) 1,900 Taxi fares 100 Lodging ($750 + $300) 1,050 $4,850 b. The answer in part a. for Amos would not change. These expenses are associated with his business as a tax attorney

Classify each of the following expenditures paid in 2018 as a deduction for AGI, a deduction from AGI, or not deductible: Barak contributes to his H.R. 10 plan (i.e., a retirement plan for a self-employed individual). Keith pays child support to his former wife, Renee, for the support of their son, Chris. Judy pays professional dues that are not reimbursed by her employer. 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. Oni 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. Ralph pays $6,000 of property taxes on his personal residence and $5,000 of state income taxes.

a. Deduction for AGI. b. Not deductible. c. Not deductible from 2018 through 2025 since the payment is not reimbursed by employer. This is an employee business expense (and a miscellaneous itemized deduction). d. $400 deduction from AGI. The $100 principal payment is not deductible. e. Beginning in 2018, moving expenses are not deductible (an exception is provided for military personnel). f. Deduction from AGI. Beginning in 2018, the deduction for personal taxes is limited to a total of $10,000. So $1,000 of the taxes is not deductible.

Aubry, a cash basis and calendar year taxpayer, decides to reduce his taxable income for 2018 by buying $65,000 worth of supplies for his business on December 27, 2018. The supplies will be used up in 2019. Can Aubry deduct the expenditure for 2018? Explain. 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

a. It is doubtful that Aubry can deduct the $65,000 of supplies in 2018 because he was motivated by tax considerations (i.e., to manipulate income). b. If Aubry bought the supplies at a discount, he would be motivated by business reasons other than tax reduction. Because the supplies would be used within the following year, the Zaninovich case indicates that Aubry could deduct the supplies.

Classify each of the following expenditures paid in 2018 as a deduction for AGI, a deduction from AGI, or not deductible: Roberto gives cash to his father as a birthday gift. Sandra gives cash to her church. Albert pays Dr. Dafashy for medical services rendered. Mia pays alimony to Bill. Rex, who is self-employed, contributes to his pension plan. Bonita pays expenses associated with her rental property. Lu, who operates a sole proprietorship, takes a client to dinner to discuss new business.

a. Not deductible. b. Deduction from AGI. c. Deduction from AGI (subject to 7.5% floor). d. Deduction for AGI provided the separation agreement was signed prior to 2019. Alimony payments related to separation agreements signed after 2018 are not deductible. e. Deduction for AGI. f. Deduction for AGI. g. Not deductible.

Suzanne, a single taxpayer, operates a printing business as a sole proprietor. The business has two employees who are paid a total of $90,000 during 2018. Assume that the business has no significant assets. During 2018, the business generates $150,000 of income, and Suzanne's taxable income before the QBI deduction is $155,000. What is Suzanne's qualified business income deduction? What is Suzanne's qualified business income deduction if the facts are the same except the business income is $250,000 and Suzanne's taxable income before the QBI deduction is $270,000?

a. Suzanne's QBI deduction is $30,000 ($150,000 × 20%). The W-2 wages and qualified property limitation does not apply because Suzanne's taxable income before the QBI deduction is less than $157,500. b. Suzanne's taxable income before the QBI deduction exceeds $207,500. As a result, the W-2 wages and qualified property limitation must be included. As a result, Suzanne's QBI deduction is $45,000, the lower of: $50,000 (20% × $250,000), or $45,000 (50% × W-2 wages of $90,000).

Shanna, a calendar year and cash basis taxpayer, rents property from Janice. As part of the rental agreement, Shanna pays $8,400 rent on April 1, 2018, for the 12 months ending March 31, 2019. How much is Shanna's deduction for rent expense in 2018? Assume the same facts, except that the $8,400 is for 24 months' rent ending March 31, 2020. How much is Shanna's deduction for rent expense in 2018?

a. The entire $8,400 is deductible since the benefit from the payment will be completely received by the end of 2019. b. Since the benefit from the payment will not be completely received by the end of 2019 (the end of the tax year following the year of payment), the only payments deductible in 2018 are for the benefits received in 2018 (nine months; $8,400 × 9/24 = $3,150).

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. Calculate the salary deduction if Falcon is a cash basis taxpayer. Calculate the salary deduction if Falcon is an accrual basis taxpayer.

a. Under the cash method, Falcon can deduct only the salaries paid of $500,000. The $45,000 of unpaid salaries can be deducted when paid next year. b. Under the accrual method, the $500,000 is deductible because both the all events test and the economic performance test are satisfied. These tests also are satisfied for the $45,000 of unpaid and accrued salaries. Consequently, Falcon can deduct the $45,000 for a total deduction of $545,000 ($500,000 + $45,000).